Higher interest, but a catch

Eileen Ambrose -- Personal Finance

March 23, 2010|By Eileen Ambrose Personal finance

The interest you earn on your checking account might be so low that you don't even notice it. But some banks and credit unions are now paying generous rates - with a slight catch, of course.

These institutions offer so-called rewards checking accounts that pay substantially higher rates - often around 4 percent - if customers meet certain hurdles, such as making a minimum number of debit transactions each month.

"If it fits your financial lifestyle, it's a slam-dunk," says Greg McBride, senior financial analyst with Bankrate.com.

Rewards checking has been around for a half-dozen years, but it has been gaining momentum in the past year or so as a way to attract deposits, McBride says.

Of 211 institutions surveyed, 58 now offer rewards checking accounts, according to Bankrate's first survey on these products released Monday. None is in Maryland, but 41 of the institutions surveyed accept customers nationwide, so Marylanders can access these accounts, McBride says.

The Bankrate survey found that the typical annual percentage yield on a rewards checking account is 3.3 percent. That compares with 0.13 percent for the typical checking account or 0.23 percent for the average savings or money market deposit account.

Of course, you don't get a high rate without strings. Banks and credit unions offering rewards checking want loyal, low-cost customers. They typically require that you make regular direct deposits into the account or pay a certain number of bills online, which is cheaper to processthan a paper check.

Almost all institutions require that you make a certain number of debit card transactions - usually 10 - each month. The reason: Institutions make money on interchange fees paid by merchants on debit transactions, McBride says.

What happens if you don't pay bills online or make the required debit transactions? You won't earn the high rate for that month and instead be paid a default annual yield, which now averages 0.16 percent, Bankrate reports. But once you start meeting the thresholds again, you will earn the higher rate.

Another catch: Banks and credit unions generally cap balances that qualify for the high rate. BECU, a credit union in Washington state, pays an annual yield of 6.17 percent for area residents, the highest in the Bankrate survey. But that only applies to the first $500 deposited.

Most institutions, though, pay their highest rate on balances of up to $25,000, the survey found.

When balances exceed the caps, customers earn the lower default rate on the excess amount. At BECU, for instance, that rate is 0.25 percent.

"For the majority of consumers, it's a pretty good deal," says Jim Ludwick, an Odenton financial planner. But he warns that those with limited means can easily blow their budgets if they don't closely track the debit transactions required under rewards checking. "People on a strict budget should be aware that the amount of rewards is a lot less than exceeding your budget and making mistakes," Ludwick says.

To make the most of a rewards account, treat it like a savings instead of a checking account, McBride says. Make the required debit transactions for small purchases, so you keep as much money as possible in the account earning a healthy rate. Meanwhile, maintain a traditional checking account that you use to pay the rent or mortgage or regular bills.

Of course, a rewards account might not be for everyone.

"You have to assess whether you can clear those thresholds on a regular basis," McBride says. "If not, the returns are very close ... to typical interest-checking accounts."

Find federally insured institutions offering rewards checking, and their terms, at bankrate.com

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