What Is an Interest Checking Account? -- SmartAsset Blog

Interest checking accounts, otherwise known as interest-bearing checking accounts, are checking accounts that pay an interest rate on the money held on deposit. There are key similarities and key differences between interest-bearing checking accounts and savings accounts. Here’s what you need to know. For more help with managing your money efficiently, consider working with a financial advisor.

What Is an Interest Checking Account?

An interest checking account is a checking account that pays interest on its funds. Most accounts generate their interest monthly and the bank pays it by adding that amount to the account automatically. These accounts generate compound interest, as each month the account generates interest based on both the principal and the previous month’s interest payment.

Typically banks advertise the interest on their checking accounts based on the annual percntage yield, or “APY.” For example, if you put $100 into an account with a 1% APY, by the end of the year you will have generated approximately $1 of interest. Although for ease of use we have not accounted for the effects of compounding in this example.

Interest checking accounts work identically to savings accounts in this way. Both accounts pay the owner a set, compounding interest rate over time. Most savings accounts also issue interest payments monthly, and most are advertised based on their annual interest rates.

However, there are two main differences between an interest checking account and a savings account:

Interest Rates

Interest checking accounts almost always pay much lower rates than savings accounts. This is because checking accounts are intended as liquid products. You can spend and deposit cash at will, which makes it harder for the bank to plan around having this money on hand for issuing loans.

Since interest is the money that the bank pays you to use your money while it’s on deposit, you receive less interest for money that you’re less likely to keep on deposit.

Liquidity

Most savings accounts have a restriction on how often you can withdraw money from the account. This allows the bank to offer you a higher interest rate for a savings account than a checking account. Interest checking accounts, by contrast, generally have no liquidity controls.

What Is a Non-Interest Checking Account?

The other standard form of checking account is known as a non-interest checking account. A non-interest checking account is similar to a standard interest-bearing checking account except that it does not generate interest over time. Otherwise, like an interest checking account, a standard non-interest checking account is a highly liquid account with no controls over moving your money. This is the standard product that most people have.

Non-interest checking accounts also tend to be less expensive than interest checking accounts in two important ways.

Minimum Balances

An interest checking account will generally require that you maintain a minimum balance in the account. This reduces the liquidity advantages of this account, since the bank will typically stop paying interest or begin charging you fees if your balance falls below this minimum. This is meant to offset the unpredictability brought on by a checking account’s high liquidity.

Non-interest checking accounts have lower minimum balances, if they have any at all.

Fees

Interest checking accounts often charge fees of some sort. Most of the time, this comes in the form of an annual or monthly maintenance fee, but the details can vary. As with minimum balances, this is meant to offset the account’s uncertainty.

Non-interest checking accounts have lower fees than interest checking accounts and typically have none at all. While historically banks tended to require either minimum balances or fees on even non-interest checking accounts, increasingly they offer these as no-fee/no-minimum products.

Uses For Interest Checking Accounts

Banks tend to offer two types of interest checking accounts.

Standard products generally offer lower rates, but also have fewer requirements and lower fees. They are also easier to find. In fact, it’s relatively common for banks to offer interest checking accounts as a premium product for customers who maintain high balances.

High-interest or high-yield checking accounts are, as the name suggests, checking accounts that offer higher interest rates than normal. They also tend to come with higher fees, minimum balances and other requirements.

In both cases, relatively few consumers actively seek out interest checking accounts. They generally fall into the category of a “nice to have” financial product. If your bank offers one of these accounts, and if you tend to maintain a five-figure balance in your checking account, it may be worth changing your account to take advantage of that offer. Depending on fee structure, the account may offer a nice bonus to money you would have held on deposit anyway.

However, while interest checking pays more than the zero-percent of non-interest checking, the rates still tend to be quite low. Within the same institution you will always get a higher rate of interest with a savings account, and after accounting for transfer fees it’s rare for an interest checking account to pay rates worth doing business across multiple institutions. These are worth asking after, and worth taking advantage of if the opportunity presents itself, but rarely more than that.

The Bottom Line

An interest checking account is a checking account which pays you an interest rate based on the balance in your account. While they generally have a minimum balance requirement and may charge fees, they can be a nice bonus if the opportunity presents itself.

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Most of the time, the best checking account is the one that meets your spending needs. But as long as you can get your money when you need it, why not make the most of that product?
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