How Do Online Banks Work?

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Advances in the realm of technology have not only been beneficial to consumers looking for the best shopping deal or individuals hoping to connect with friends and family – old-school financial products and services have come into their own with the help of technology. Individuals have the ability to find a loan, a credit card, and even a new bank on the World Wide Web, making managing personal finances a breeze.

But some are skeptical of the emergence of so-called online banks, with confusion surrounding how they work in comparison to traditional financial institutions. Here we’ll break down the ins and outs of online banks, how to find one, and special considerations for use.

What is an “online” bank?

Throwing the descriptor “online” in front of anything makes it seem appealing to some and scam-like to others. Fortunately, banks that bear the online name mostly fall into the first category. Some confusion lies in where money is held and how it is distributed, but online banks are virtually no different than your local bank branch. There is one clear difference though: an online bank is simply a financial institution that is housed on the Internet, as opposed to having a brick and mortar branch location.

What can an online bank offer?

The majority of credible online banks offer the same menu of financial products and services as financial institutions with physical locations. They offer savings and checking accounts, money market deposit accounts, certificates of deposit, and both traditional and ROTH individual retirement accounts (IRAs). Online banks may also offer access to credit cards, personal loans, and mortgages, depending on their breadth within the market.

Just like with traditional banks, online providers offer debit cards and checks for corresponding accounts, so access to your money is no different. In most cases, banks housed online have intuitive desktop and mobile applications where customers are able to make transactions, open new accounts, and transfer money to other financial institutions as they see fit.

The benefits of banking online

The disruption of financial technology has proved beneficial to banking customers in the perks afforded by online institutions. Online banks offer a level of convenience not easily matched by conventional financial institutions because of how accessible they are. Because there is no physical branch location to visit to complete common transactions, online banks have no choice but to deliver top of the line access over the Internet.

Lower interest rates

In addition to ease of access, online banks have one clear advantage over traditional banks and credit unions. Without actual locations that customers can walk into, online banks have far less overhead in terms of rent and property expenses. The lack of financial burden allows online banks to offer benefits to customers by way of higher interest rates on deposit accounts. In some instances, online banks that offer lending products may pass the overhead savings down to customers through lower rates on personal loans as well.

For example, the Federal Deposit Insurance Corporation reported the average interest rate for savings accounts within the United States at a dismal 0.06%, as of April 2016. That equates to an annual interest accumulation of $6 on a $10,000 deposit. Not all that exciting, to say the least. In comparison, the average interest rate for online banks is 1.00%, which equates to an annual accrual of $100 simple interest for the same $10,000 deposit. That $94-dollar difference is enough for some banking customers to make the leap to online banking.

Lower deposit rates

But the benefits don’t stop at convenience or interest rates. The top online banks generally have no or relatively low minimum deposit amounts, specifically for checking and savings accounts. It is also hard to find an online bank that charges fees for transactions like direct deposit, internal or external transfers, or withdrawals. Unlike some brick and mortar financial institutions, online banks are free of the allusive maintenance fee as well. All of these benefits offered by online banks create a way to make your money work harder for you, without costing a pretty penny.

Special considerations with online banks

On the almighty Internet, bad apples lie around every corner. It can be a challenge to determine with full faith which companies found online are legitimate and which are at best, questionable. The threat of finding a bad apple in the online banking world is less concerning given financial regulations in place from government and private authorities, but it is necessary to do a bit of research prior to making the move to an Internet-based financial institution.

Check their website

To ensure you’re getting the most of your banking experience with an institution that is on the up and up, do some snooping on the provider’s website to start. Most legitimate online banks will have a professional “About Us” page, and the details listed in this section should provide the information you need to either move forward to continue your search. For instance, online banks that truly provide the same services as a traditional financial institution will be FDIC insured, and that information should be clearly listed on their site with the terms “Member FDIC” or “FDIC Insured”. Just like well-known banks, deposits held with an online bank have insurance coverage provided by the FDIC in the event the bank becomes insolvent. Your deposits are protected up to certain limits, depending on the type of account held and the number of account owners.

Look for a physical address

In addition to checking for FDIC insurance coverage, your research should quickly lead you to an actual address for the online bank’s headquarters or national offices. Although online banks do not have branch locations, they must still have a physical address from which they do business. If you can’t seem to find that information for a bank you are researching, it may be necessary to find an alternative.

Finally, take care to protect the personal information you share online. The Internet is mostly a safe place to conduct business, but if something feels off – a less than professional web presence, bogus contact information for the bank, or requirements for upfront payments or other bank account information – move on to another choice. Online banking can be a smart move toward managing your personal finances in an efficient way, but it is up to you to ensure you are banking with a real, secure institution online.

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