Pros And Cons Of Online Banks

Online Banks Often Provide Higher Yields on Savings Accounts

When the markets turn volatile, people tend to seek out safer places to stash their cash. Naturally, some have turned towards the high-yield savings accounts of online banks. The appeal of these banks is clear -- many of them offer interest rates that are far higher than traditional brick and mortar banks. For example, one of the leading online banks may be offering an interest rate of 3.50% APY on their savings account.

Compare that to your local community bank's savings account rate of 0.20% APY -- that's a difference of 3.20%. On an account balance of $10,000, that's a difference of several hundred dollars a year in interest.

However, there are some risks and drawbacks to online banks. Below, you’ll find some of the pros and cons to having your savings at an online bank.

Benefits of Online Banks

High yield interest rates: The greatest benefit of using an online bank is generally the interest rate. The interest rates on their savings accounts are almost always higher since their overhead is lower. There are no branches to maintain, no tellers to pay for, no branch managers or janitorial staff. Without those added expenses, banks can pass the savings on to customers in the form of higher interest rates.

Superior online website interface: Since 99% of your interactions with an online bank will be through a website, online banks typically have very sophisticated websites with plenty of features and a very fast response time.

Many brick and mortar banks that offer online capabilities often do so as an afterthought.

Opening an account is quick and easy: As a result of being entirely online, anything you need to do can be done online at any time. If you feel like opening a new CD on Sunday night, you can. You don't have to wait for a branch to be open, you don't have to drive to the branch, wait in line, and then fill out paperwork or meet with a banker.

You can do your banking on your own terms.

Drawbacks of Online Banks

Websites can go down: While rare, it's not unheard of for the websites of to go down. In 2008, HSBC Direct suffered a technical failure that rendered its website inaccessible for quite some time. Banking business was conducted as usual (deposits were registered, withdrawals were processed, etc.) but customers couldn't log into their accounts. Several years ago, Emigrant Direct upgraded their website, and the deluge of visitors checking out the new site made it inaccessible for a few hours. In the end, it’s still a website, and websites can become inaccessible, which could force you to use the phone, or worse, be unable to make an important transaction.

You can't go to a branch: There is something comforting about being able to go somewhere and talk to someone face to face. With online banks, the relationship aspect of banking, which is most critical when dealing with loans, is gone. Some online banks offer loan services such as mortgages and car notes, but by and large, most people still trust brick and mortar banks for those types of services.

Lower Certificate of Deposit rates: While the savings account rates are often higher at online banks than their brick and mortar brethren, the same can't be said for certificates of deposit.

The best certificate of deposit rates are usually found at the brick and mortar banks. I don't know the reason for it but empirical research has shown that the leaders in terms of CD rates often don't have an online savings account option available. This reduces the ability for "one stop shopping" at online banks, which may or may not be a problem for you.

Bottom Line

Overall, I generally think the benefits of high-yield savings accounts at online banks outweigh the drawbacks. While they may not be ideal for conducting your day-to-day transactions, they make a great place to stash away some money for a rainy day or hold your emergency fund and earn above-average interest.