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High-yield savings accounts have become a popular place for consumers to stash their cash because they offer higher interest rates than traditional savings accounts. But if you have a high-yield account, you may have noticed your rate fluctuates—and during the coronavirus pandemic, it's likely gone down.
Here's what you need to know about how savings rates work and why high-yield savings accounts are still one of the best places to park your short-term funds.
What Is a High-Yield Savings Account?
A high-yield savings account is a type of bank account that typically pays a much higher annual percentage yield (APY) than a traditional savings account.
Compared with the average savings rate of 0.05% as of Oct. 2020, according to the Federal Deposit Insurance Corporation (FDIC), some banks and credit unions offer 10 times that amount or more. In the past, some high-yield savings APYs have exceeded 2%.
To give you an idea of what that means, let's say you have $10,000 saved in an account offering a 0.05% APY, but you move the funds to a high-yield savings account to get a 0.80% APY instead.
In the first scenario, you'd earn just $5 on your deposits over the course of a year. In the second, though, your earned interest increases to $80.
That's not a huge difference, especially over the course of a year. But the more you save and the longer you hold your money in the account, that extra interest can add up.
High-yield savings accounts are a perfect place to put your emergency savings or any other short-term savings that you don't want to tie up in a certificate of deposit (CD) or an investment account.
When Do Interest Rates Change on a High-Yield Savings Account?
The APYs on deposit accounts, including interest-earning checking accounts, traditional savings accounts and high-yield savings accounts, are typically variable.
This means that your interest rate can change at any time, often without notice. More specifically, deposit account rates are tied to the federal funds rate set by the Federal Open Market Committee (FOMC), which sets monetary policy for the Federal Reserve.
The federal funds rate is the rate at which banks borrow from or lend to each other overnight to meet reserve requirements. A high rate typically means that the economy is doing well. Lenders tend to offer higher interest rates on their high-yield savings accounts—and also charge higher interest rates on loans and credit cards—when the federal funds rate is higher.
On the flip side, if the FOMC cuts the federal funds rate, it's generally a sign that the economy is contracting. As a result, lenders typically offer lower deposit rates and charge lower interest rates on new credit.
In March 2020, the FOMC cut the federal funds rate to near zero, then announced in June 2020 that it expects to maintain the rate at that level through 2022. After the FOMC made its decision, high-yield savings rates started falling, and they'll likely stay relatively low—though not nearly as low as standard savings account rates—for some time.
What to Do When Rates Get Too Low
When savings rates get low, you may wonder if there's a better place to put your money. Ultimately, the answer depends on your financial situation and goals.
For example, if you have money set aside for emergency expenses, using a high-yield savings account as your emergency fund is likely the best move. The lower rate isn't enough to keep up with inflation, but that money is earmarked for a rainy day, so making a lot of money off the balance isn't a priority.
How much you save in your emergency fund is up to you, but financial experts recommend having three to six months' worth of your basic expenses in savings in case of emergency.
That said, if you have enough money for emergencies plus some, now may be a good time to put that surplus to work with your other financial goals.
For example, if you have credit card balances or other high-interest debt, you could use that extra money to pay off some or all of what you owe. The faster you can eliminate your debt, the more money you'll save on interest.
If you have some long-term goals, such as saving for retirement, you could consider investing your money to potentially increase your return on investment.
As you decide the best path for you, the key is understanding what you want to do with the money and whether you can risk losing it. If you use all your savings to pay off debt, you won't have a safety net if you lose your job or have to deal with expensive home or car repairs. And if you invest all your money and the market goes down, you could lose hundreds or even thousands of dollars in the process.
Think carefully about these factors and your situation to make the right decision for you.
Monitor Your Credit to Increase Your Savings
Your high-yield savings account rate isn't influenced by your credit score. But when the federal funds rate goes down, so does the prime rate, which lenders use to determine how much interest to charge on loans and credit cards.
If you need to borrow money, a low-rate environment is the best time to do it. But if your credit score isn't in good shape, you may still end up paying more than you need to.
Monitoring your credit is key to helping you understand where you stand with your credit history and which areas you can address to improve it. You can generally qualify for favorable rates with good credit, which starts at a FICO® Score☉ of 670, but the higher your score, the better.
With Experian's credit monitoring service, you'll have free access to your FICO® Score and your Experian credit report. As you check regularly, you'll be able to see how your actions affect your credit score. You'll also be able to view the information on your credit report, which can help you decide which steps to take next with your money.