What’s the Difference Between a Checking and Savings Account?

The difference between a checking and savings account may seem obvious, but there are details about each that every consumer should know. Before we wade too far into the weeds, lets begin with the basics:

Checking 101

Checking accounts are said to have begun in Boston in 1681. Businessmen, strapped for cash, wrote these early versions of checks against mortgaged land in order to keep their businesses afloat. The first printed checks were produced in England in 1762 and the practice of writing checks took hold. By the year 1952, the number of checks written hit about 8 billion. 28 million checks were being written every single day and each of those checks had to go through two or more banks in order to be fully processed. It’s fun to wonder what our forefathers would have thought of our current ability to have money withdrawn from our checking account instantaneously.  

There are a number of different kinds of checking accounts. Whether an account belongs to an individual or other legal entity, it offers similar features. For example, most checking accounts do not offer a high-interest rate, but they are guaranteed by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per individual depositor. The low-interest rate paid on checking accounts is a tradeoff for liquidity, meaning it can be withdrawn without penalty at any time.

An exception to the low interest rule involves accounts with very large balances. In an effort to keep those account holders happy, banks often provide a service referred to as a “sweep.” A sweep involves withdrawing most of the cash from an account and investing it overnight in an interest-bearing fund. The funds are then deposited back into the checking account at the beginning of the next business day along with any interest it earned. The interest earned during a sweep is certainly greater than the interest that would have been earned if the money had been left in the account.

It wasn’t so long ago that one had to go into their local brick and mortar bank in order to set up a checking account. The advent of the ATM and the Internet have changed all of that. Today, customers can start a new checking account simply by logging in online. They can perform some of the same duties once carried out by bank employees by visiting a local ATM to make deposits, check their balance, or withdraw cash. It’s not at all unusual for a bank customer to pay bills from their smart phone app rather than writing a check.

While many customers consider their checking account a necessity, banks consider them a loss leader. In short, a loss leader is a product a company offers, understanding that it will not earn them a profit. The role of a loss leader in any business is to attract new customers. All those free or low-cost checking accounts you see advertised? Banks use them as a way to draw in customers who will eventually take advantage of services that actually make money for the bank, things such as taking out a mortgage or investing in a Certificate of Deposit. In the event your bank increases fees on your checking account it is likely because they did not sell enough profitable products to cover their losses.

Features of a Checking Account

Mileage will vary by the checking account, but most banks offer accounts with a multitude of benefits, including:

­­­­­­­­­­­Overdraft Protection: Say you write a check for $1,200 but you only have $1,180 in your account. Overdraft protection means the bank will cover the difference and possibly, charge you a small fee for doing so. While fees are never fun, overdraft protection fees are generally much lower than customary overdraft protection.

Overdraft protection is in place to save you from high overdraft fees. Many banks include small print in their banking agreement saying that they can group transactions together and charge you a fee for each of them. With fees ranging from $20-$40 each, overdraft fees can climb quickly. Overdraft protection is a benefit that can save you a bundle.

Other Overdraft Options: If you’d prefer to provide greater protection (and avoid overdraft fees all together) you can choose to tie your checking account to a savings account or credit card.

ATMs: ATMs add convenience to your life by allowing you to access cash after regular banking hours, make deposits, and even check your balance when you don’t have access to the Internet.

Direct Deposit: Allows your employer, the IRS, or another person to bypass you and directly deposit money into your account.

Electronic Funds Transfer (ETF): An ETF is also known as a wire transfer and allows you to have money transferred directly into your account.

Debit Cards: Debit cards offer you the opportunity to leave home with no cash. They give you all the benefits of a credit card without the concern that you will overspend and end up with a high interest bill. Some banks also offer fraud protection designed to protect against identity theft.

Savings 101

Savings accounts are designed for people who want to keep money that they don’t need for daily expenses. Since savings accounts pay interest, it makes more sense to keep your money in a place where it will grow, however slowly. One of the reasons savings accounts pay such minimal interest is that, like checking accounts, they offer liquidity. No, your bank may not allow you to withdraw all of your money at once and you may have to pay fees if you make too many withdraws in a month, but compared to stocks, bonds, or retirement accounts, it is much easier to access money in an emergency situation.

One downside of a savings account (as compared to the abovementioned stocks and bonds) is that it’s far easier to withdraw from a basic savings account when money gets tight or there’s an impulse to buy something you can live without. The other downside is how very low saving account interest rates have been and how much more you could earn through other investment vehicles.  

The “Other” Savings Accounts

If you’re looking for a higher interest rate, these savings instruments might be your best bet:

Certificates of Deposit (CDs): Like a regular savings account, CDs are FDIC insured. You will earn more interest (with one catch). You must agree to leave your money alone for a specific period of time. You can withdraw funds early but will get hit with a penalty. CDs make sense if you’re confident that you won’t need the money before the CD matures.

Money Market Accounts (MMAs): MMAs usually pay more interest than a basic savings account but may also require a larger initial deposit. Unlike a CD, you can write checks against an MMA and some banks even allow you to link it to a debit card. Like a basic savings account, there may be limits on how often you can make withdraws.

The Bottom Line

A checking account is designed for regular use, while a savings account is meant to be a risk-free place to save either short or long-term.

Whereas most checking accounts offer no interest, basic savings accounts do (albeit modest). CDs offer greater interest, but your money is locked in for a set period of time.

The average checking account allows unlimited withdrawals, but banks frequently limit the number of withdrawals you can take from a basic savings account each month. In addition, your bank may only allow you to withdraw a portion of your account balance, regardless of your circumstances.

One final difference. You can withdraw money from an ATM almost anywhere across the globe. If you need money from your savings account you may have to make other arrangements (like transferring it from savings to checking or requesting a wire transfer).

A checking and savings account each serves a specific purpose but work well together to form a financial foundation for your future.