While Feb. 22, 1999, will escape most of us as a day of any financial significance, it marked the launch of First Internet Bank of Indiana – an event so auspicious, it was held at the Museum of American Financial History in New York City. But for those lucky enough to attend, finding a teller or branch manager to exchange high fives with was literally impossible. As the name indicates, First Internet Bank (as it’s now known) exists only in cyberspace. It was recognized as the first “extended value online bank” to offer extensive banking products. (An earlier internet bank had opened four years before.)
Now, online-only banking has exploded.
So how do online banks work? What makes them different from traditional banks? And which advantages should make you consider one, along with the crucial differences you need to note? Here’s a closer look at how the online banking world breaks down.
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Today, practically all banks and credit unions offer online access, bill payment, cash transfers and other such services. That’s important for the banking industry because consumers clearly want to bank on the go, with their mobile devices front and center. Research in 2018 by the nonprofit Bank Administration Institute shows that 51 percent of millennials would switch banks just to get a better banking app; so much for the teller’s smile keeping clients happy. Close to four in five bank customers with mobile apps use them to check account balances, while slightly more than half do so to transfer funds, according to a 2017 survey by payments provider TSYS.
Thus the nation’s banks have developed ways for customers to bank online. Some of the features they offer are incredibly slick and convenient, such as remote deposit capture, where you can take a picture of an endorsed check with your smartphone and move it to your account – quite literally a financial snapshot.
You’ll find the same offerings and more at online banks, but with one unmistakable difference: There are no physical bank branches to visit or tellers to interact with. In some cases, you might get matched up with someone who can help you; banks such as First Internet have “relationship bankers,” trained to answer a variety of financial questions via online chat, phone or email.
As a rule, online banks will have accrued far less time in the business than their traditional counterparts. But in large part due to their lower overhead, online banks can offer higher interest rates on checking and savings accounts.
“Brick-and-mortar banks may soon be a thing of the past, as many are now comfortable doing their banking online versus making a trip to the bank,” says Steve Azoury, owner of Azoury Financial in Troy, Michigan. “As we have seen, direct deposit of payroll while in the beginning seemed odd, is now preferred everywhere.”
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Here’s a step-by-step process for opening an account with an online bank:
- Go to the online bank’s website. There, you’ll find a button or link that sends you to an account-opening page.
- Make sure you have the necessary documentation handy. You’ll need your Social Security number, a valid form of identification such as a U.S. driver’s license or other government-issued ID, a U.S. address for a physical residence (not a P.O. box), and proof that you’re a U.S. citizen or resident alien.
- Create an application login. This will also ask you to pick a username.
- Pick the account type. If it’s a joint account, you’ll need the above documentation for the other account holder as well.
- Fill out the application:
- To deposit money from another bank account to open the new one, you will need debit card information, or routing and account numbers. Your checking account routing and account numbers (in that order) are on the bottom of your check.
- If you don’t have another account, you still have options. (See below.)
Do you have to open the bank account online, or can you do it over the phone?
Online banks will have a customer service line, and you can call it to get assistance with opening an account. In many cases, you can open the account over the phone as well. If in doubt, be sure to ask as soon as you reach a customer service representative.
How much do you need for your first deposit?
Many online banks do not require that you carry a minimum account balance nor will they charge you any fees, even if you keep just one dollar in the account. Even if there is no minimum, the bank will often ask you to start with at least $25 or more. Whenever possible, check in advance to avoid wasted time on hold.
How do you get the funds to the bank?
If you have another bank account, you can transfer the money into your new account. If you don’t, it’s trickier; after all, you can’t send cash over the internet. But some banks may work with you to remotely deposit a money order via their app. In that case, it’s definitely a smart idea to work with a customer service representative or online banker as you go.
How will I be able to access my funds once I get them in the account?
If you’re opening a checking account, you can usually write checks just as you would at any other bank. Online banks also have debit cards that you can use at ATMs or to get cash back at retailers. You could also transfer your funds to another bank account you can access.
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Look for internet banks affiliated with the Federal Deposit Insurance Corp. seal, which are federally insured just like FDIC brick-and-mortar banks. With online credit union accounts, the National Credit Union Administration serves a similar function to the FDIC.
Are online banks more vulnerable to hacking?
Granted, online banks lie 100 percent within the same digital realm of cybercriminals. But the most powerful crooks want big, fast and easy scores. They usually target cybercurrencies such as bitcoin and large entities with obsolete digital security.
Make no mistake: Your online bank is vulnerable to hacking – just like any other business that operates online. Two-thirds of online banks and banking portals have at least one critical vulnerability, according to a 2018 report by Positive Technologies. Now what?
With an online bank, be sure that it:
- Can prove it has robust internet security measures.
- Has its accounts FDIC or NCUA insured.
- Has never made headlines for careless data mishaps.
How do you protect yourself while banking online?
- Strengthen your password. A password with upper- and lower-case letters, symbols and numbers in random combination is much harder to hack. Just make sure you can remember it; one strategy is to pick an acronym such as “I really love ice cream” and use the first letters “Irlic” in the password.
- Use biometrics whenever possible. Some mobile banking apps offer what’s known as biometric authentication. This allows you to confirm your identity using a unique physical trait, such as your voice, thumbprint (a popular method on mobile devices) or facial/retina scan. While not commonly offered now across all institutions, the popularity and ubiquity of biometric authentication is growing. If you have access to it, begin using it now. A personal identification number is easy to steal, but your thumbprint is for all practical purposes impossible (despite what those spy movies tell you). When biometrics are used with a password and/or security token (a code number the bank texts to your phone to make sure it’s you), banks refer to it as multifactor authentication.
- Keep an eye out for alerts. Online banks aren’t the only ones open to data breaches and hacking of valuable information. Just ask Equifax and Target, victims of two of the biggest data thefts in financial and retail history. The only silver lining if your bank has been hacked is that you may receive a timely security alert. If so, stop all banking activity until the financial institution instructs otherwise.
- Protect yourself while banking in public. Always protect your password information when you use your mobile banking app in public places. Coffee shops, for example, are notorious hangouts for those who “shoulder surf” – that is, spy on people from behind as they conduct sensitive online business. Treat mobile banking on the go as you would any private phone call. Keep your keystrokes well-guarded, close your app the moment you’re done and save conspicuous activities such as check deposits for times when you’re alone.
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Online banks have noteworthy advantages. Among them:
- Better rates. With less expenses focused on employees and branch operations, online banks have a distinct edge in offering a better annual percentage yield. The best savings yield as of March 2020 is the 6.17 percent introductory APY (good for up to $1,000) from Digital Federal Credit Union. Ally Bank offers 1.75 percent on an 18-month certificate of deposit and 1.5 percent for savings. By comparison, Chase offers 0.1 percent APY for its 18-month CD and 0.01 for its savings account.
- Lower or no fees. Ally Bank is typical among its online peers in that it charges no monthly maintenance fees, requires no minimum balance and will reimburse some fees for ATM usage outside its network. Among traditional banks, Citi’s Basic Banking/Simple Checking package charges a $12 monthly service fee unless you make one qualifying direct deposit and bill payment per statement period, or maintain at least a $1,500 combined average monthly balance in your eligible Citi accounts.
The disadvantages include:
- Lack of face-to-face contact. That’s a problem when you need a banker to answer more complex financial questions that can’t be addressed via touch screen. Some online banks, however, work with individual bankers you can choose from. It’s not that online banks necessarily have worse customer service – they offer mobile chat and call centers – but you might still covet that branch experience when the need strikes you. That’s even true of millennials, often stereotyped as a digital-only generation. The Bank Administration Institute found in 2018 that when shopping for a bank, millennials listed convenient branches as their top priority – just like Gen Xers and Baby Boomers.
- Nonexclusivity online. Traditional banks now offer online/mobile banking as well, so it’s not as though you have to go to an online bank to get those conveniences.
- Site disruptions. Dependent as they are on digital technology, online banks effectively close their doors when networks go down, servers crash or technical glitches occur. What’s more, your ability to bank depends entirely on the availability and quality of your internet connection.
- Lack of track record. Considering that the oldest online-only bank in operation is just 20 years old, that’s hardly a match for traditional institutions such as Capital One (1988), Bank of America (with roots dating to 1904) or The Bank of New York Mellon (1784, founded by Alexander Hamilton). To be sure, online-only banks have largely avoided the bad behaviors of those big banks that fueled the Great Recession. But how these smaller, less seasoned institutions will weather any future financial crisis remains to be seen.
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Online banks do not have their own ATMs branded with the bank’s name. That could leave you vulnerable to ATM fees, unless the online institution has an agreement with an ATM network. Sometimes, your fee-free ATM options may be more limited than with a regional, super-regional or major bank. Make sure to scope out the ATMs in your area to see which ones you can use without getting dinged: a good idea in any event, but especially if you have an online-only account.
Do note, though, that online banks will often reimburse for the fees you accrue using out-of-network ATMs.
Savvy online banks also allow you to use map locators to find fee-free ATMs. When you enter a ZIP code or street address, this map from Ally Bank can locate ATMs in your vicinity. Digital Federal Credit Union’s ATM locator indicates which ATMs are fee-free, which belong to its branch network and which take deposits.
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“I think it is important to look for an account that offers no minimums, no fees and FDIC insurance,” says Kristian Finfrock, founder and financial advisor at Madison, Wisconsin-based Retirement Income Strategies. “There are many good options available today that pay in the neighborhood of 2 percent. This is a great rate for your emergency reserve account.”
Consider these 10 features when looking for the online bank that’s right for you:
- Ease of opening accounts. Provided you have the necessary documents handy, you should be able to open an online account in minutes.
- Customer service availability. Zero branches should never equal zero customer service. On this measure, all online banks are hardly alike. Check for easy phone access and extensive hours for live chat and call-in help. Having an online banker you can pick is also a bonus.
- High customer service ratings. Not all online banks will have extensive ratings handy, but you may find them listed in rankings by various websites.
- Zero fees. Fees in the banking world are everywhere, and online banks have sought a competitive advantage by eliminating them. The best online banks will scrap fees for monthly service charges and minimum account balances. They may also reimburse ATM fees for using machines outside of their network.
- Ease of making deposits. Taking a front-and-back picture of a check with your smartphone and depositing it should take no more than two minutes. You’ll also want nearby ATMs that can accept cash deposits.
- Higher interest rates on checking/savings. In general, online banks will beat brick-and-mortar institutions. But among online and mobile banks themselves, there’s healthy competition for your business. Shop the rates to get your best deal.
- Lower interest on loans and credit-related products. Online banks often are quite competitive with traditional banks and credit unions, but be sure to shop around.
- Variety of products. Online banks should give you options beyond checking and savings accounts. Look to see whether the bank offers mortgages, home improvement loans, auto loans, credit cards and more.
- Security/peace of mind. There’s no point in joining forces with an online bank if you’ll always worry about the safety of your money. Remember that all online banks and banking sites are vulnerable to hackers, but some will do a much better job keeping you abreast of their security measures than others.
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APY. Annual percentage yield; the effective annual rate of return for a bank account due to compound interest.
Biometric authentication. A method where an online bank or banking app confirms your identity using your voice, thumbprint or facial/retina scan. Using biometrics along with a password and/or security token number is known as multifactor authentication.
Certificate of deposit. A CD is a deposit account with a term or maturity. A CD is also called a time deposit or time deposit account.
Credit union. A nonprofit money cooperative that functions much like a bank. Members can borrow from pooled deposits at generally low interest rates. Savings accounts at credit unions typically accrue more interest than at banks.
Direct deposit. When the funds in a check are routed directly to your account without your having to endorse a paper check. Direct deposit is commonly used with employee paychecks.
FDIC. The Federal Deposit Insurance Corp., which insures bank accounts online and in traditional banks. The government agency that serves the same function for credit unions is the National Credit Union Administration.
Funds availability. The amount of money in an account that the account holder can use. When the account balance is higher than the funds available, it often reflects that the funds in a check deposited to the account have not yet cleared.
Mobile banking. A type of online banking conducted through a mobile app. The most common use of mobile banking is to check account balances, followed by direct deposit.
Online bank. A financial institution that exists only on the internet, without physical branches. Some use bankers whom customers can contact via chat message, phone or email.
Online banking. Bank transactions conducted via the internet, such as check deposits, account transfers and bill payment. Traditional banks with branches also allow customers to bank online.
Remote deposit capture. A method of depositing endorsed checks into an account by submitting pictures of them through a bank’s mobile app.