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Why Are Savings Account Rates So Low?

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US Federal Reserve SealHave you seen the interest rates on savings accounts lately? Our list of high yield savings accounts basically peaks at 1%. (As of this writing, we have just three banks with “high yield” interest rates above 1%… but barely above 1%) I can barely type high yield because when I see a single percent, I don’t think high yield. I barely even think “yield” because you’ll get exactly one dollar for every hundred dollars you save in the bank. That’s it!

You might be wondering why rates are so low. I’ll explain.

Who Sets Bank Interest Rates?

Banks set their own interest rates. A bank wants deposits because the bank will lend out that money and earn income on the difference between what it’s paying depositors in interest and what it’s collecting from borrowers in interest. A bank pays you, the saver, 1% and collects 4-5% from a mortgage borrower. The spread between the two helps pay for the lights, tellers, and loan officers. Banks are obviously far more complex but that’s the basic idea.

When a bank wants more money, it offers higher rates because it knows savers will go to where the rates are highest. They’ll also offer higher rates for a little more certainty, like with a 5 year CD. Since you can withdraw your money from a savings account at anytime, they’re willing to pay more knowing you can’t take your money and run whenever you feel like it.

Another factor, besides the bank’s need for money, has to do with the Federal Reserve’s setting of the interest rate. The Federal Reserve bank lends money to banks at a set rate, known as the Federal Discount Rate. The Fed also sets rates at which banks lend to each other, which is the Federal Funds Rate. Savings rates will rarely be much higher than these target rates because a bank would rather borrow from the Fed or other banks than raise rates and have to deal with hundreds or thousands of new customers. If you can borrow money for less than a percent, why pay more for the pleasure of dealing with more customers? There are exceptions to this but generally the Federal Reserve’s rates act like a gravitational pull. Right now, the rates are set at effectively zero – so it’s hard to see “high” interest rates.

When Will Rates Go Up?

If the Federal Reserve raises the target interest rates, you probably won’t see much activity in savings account interest rates. You’ll see small changes, like new banks offering 1.05% rather than 1.00% just to get new customers, but big shifts probably won’t be happening until our economy recovers enough that the Fed worries more about inflation. Right now, it doesn’t appear that there’s much chance of it happening in the near future (investors use federal fund futures to try to guess when the rates will increase and so that’s our best guess) so I wouldn’t hold your breath.

Until then, your best option for slightly higher yield is to go with certificates of deposit or consider a Series I savings bond (as long as you won’t need the money within a year). Those won’t give you incredible interest yield but it’ll be better than a savings account and there’s little risk you’ll be locked into a yield that will be lower, in a year, than a savings account.

(Photo: gammaman)

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10 Responses to “Why Are Savings Account Rates So Low?”

  1. DMoney says:

    So, the Fed is essentially penalizing savers because they want to spur spending. Great idea, guys.

  2. Jim M says:

    For those of us with mortgages – these lower interest rates have been a blessing. Through refinancing, it costs me hundreds of dollars less each month to live in the same home. A win for me.

  3. On a personal level it stings that savings are earning almost no interest which is a micro view, however on national scale the macro view if everyone saves both people and companies there is no increase in product and service demand so companies have no incentive to increase hiring, and the current unemployment situation ensues. If people and companies spend their money demand increases and hiring resumes then more people have money to spend.

    Sadly the current low rates have not been enough to spur spending and hiring, but there are limits to what monetary policy alone can do, however if rates were to suddenly go up spending would decrease and savings would increase which is exactly the opposite of what our economy needs right now.

    So once again if you are in the minority group who is getting hurt by the low savings rate it is unfortunate that you are getting punished for doing all the right things, however your overall situation would be worse if you were able to get 2% in a money market account and the majority of people and companies who are debt ridden were able to spend less because all the rates they are charged went up the economy would slow further and unemployment would increase.

    Taxes and other policies need to be changed to entice spending, and this has gone from a financial problem to a political one, once policies entice spending and unemployment drops, then rates can begin to increase.

    Don’t expect rates change much for the next 2 to 3 years.

  4. It does stink that interest rates are so low on savings but I love the fact they’re so low on mortgages! I think it’ll be a couple years at least before they start edging up again. I remember when I first went to an online bank I was getting 3-4% interest!

  5. Have you gotten a chance to read Bill Gross’s monthly newsletter?

  6. Do you think the Fed is trying to revive the economy with more housing purchases? Keeping interest rates low can sometimes stimulate housing, but it can’t work if workers aren’t being paid enough to afford a house. Also with jobs being less secure, it’s not going to make people ready to buy a house.

    So other than mortgage rates, why would the Fed want to keep interest rates low?

  7. Shorebreak says:

    U.S. Fed says ‘spend’ but worried Baby Boomers won’t listen

    http://business.financialpost.com/2012/11/12/u-s-fed-says-spend-but-worried-baby-boomers-wont-listen/

  8. Dave says:

    You can easily get a guaranteed return of 12% on your money if you have a credit card. It makes no sense losing 12% while earning 2% in a savings account in your bank.

    If you don’t own your home 100% then you can get a guaranteed return of 5% by paying it off. Getting 5% is better than 2%.

  9. Frotroz says:

    But still I think 12% is enough to make extra money when you are having no other business idea.

  10. admiral58 says:

    I like how Dave thinks. You might as well pay off your credit card balances now, and keep only a little bit in savings. Why? Because if you ever do lose a job, you’ll be turning to your credit card to start paying for things, so you might as well earn rewards points on things you normally would pay for anyway.


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