You have decoded your paycheck, made a monthly budget and are ready to take on the world! Well, not quite. Before you start spending, it is important to understand the banking options available to you; in other words, where and how you can store and utilize the money that you have worked so hard for.
In the banking world, there are 4 common types of bank accounts:
- Savings accounts, the most basic type of bank account, provide customers with a safe place to house their money so that it is accessible in case of an emergency, but not as accessible as in a checking account. This helps to prevent you from spending money on unnecessary items. A big incentive in opening and using a savings account is that banks pay interest (a percentage of your total money that the bank pays you for storing it with them) for the money that you keep in your savings account. Interest rates, also called Annual Percentage Yield (APY), for typical savings accounts range anywhere from 0.01% to 1%. Check this out — a savings account holding $500, with a 1% interest rate would have a balance of just over $525 after one year. (thanks compounding interest!). While a $25 increase may not seem substantial, just remember, you didn’t have to work at all to earn it!
- Basic checking accounts are another common type of bank account. These accounts are great for making easy, day-to-day transactions using your checkbook or debit card. Basic checking accounts usually offer no interest and are very easy to apply for. Some banks have limits to how many checks can be written per month and will also charge you for taking more money out of your account than you have in it; this is called an “overdraft” or “bounced check.”
- Interest-bearing checking accounts (also called negotiable order of withdrawal (NOW) accounts) are exactly what they sound like; they are like checking accounts in almost every way, but they have the added bonus of paying you interest for the money in your account. Because of this added perk, these accounts are typically harder to apply for.
- Certificates of Deposit (CDs) are basically a more intense version of your standard savings accounts. While you can take money out of savings accounts, even if it is more difficult than taking money out of a checking account, CDs require the account holder to leave their deposited money in the account for a set time decided by the account holder (usually more than 1 year). Because of this, there is a penalty for withdrawing money from these accounts before the time has expired. However, because the account holder will not be able to withdraw any money from the account during the set time period, the interest rates for CDs are substantially higher and can earn more money.
Depending on your bank, age and credit there are many more types of accounts available, but these basics are a great place to start. Getting familiar with these types of accounts and others is an important step in becoming financially strong.