Online Banks Branch Out

Although the deal hardly seemed irresistible, it still turned Amy DuBois's head. DuBois, a 27-year-old saleswoman in State College, Pa., opened an online savings account in January 2005 at ING Direct when ING was paying 2.33%, or about a percentage point more than she could get at her local bank. At first, she used her ING account as a rainy-day fund. Then she saved at ING for her wedding last August. She still has the account, which now yields 4.5%. More important in the competitive world of banking, DuBois has no qualms about stashing cash in cyberspace indefinitely. More and more of us appear to feel the same way.

About 10 million U.S. households save online, according to Celent, a market-research firm, which predicts 23 million by 2010. To lure customers, e-banks pay much higher rates on savings accounts, money-market accounts and certificates of deposit than traditional banks do. That may be true even within the same institution. If you open a traditional savings account at a Citibank office, you'll get about 0.7%. Sign up with Citibank eSavings at Citibank.com and you can score 5%. Savings is just one aspect of e-banking, however. Are online banks' checking accounts and loans competitive with those of traditional banks? They're not bad, but not thrilling enough to keep you from considering all your options.

Behind the high rates

Chalk it up to technology and creativity. ING Direct, the granddaddy of high-yield savings, first offered high-yield savings accounts in Canada by phone and mail in 1997. Arkadi Kuhlmann, who was then with ING in Canada and is now chief executive officer of ING Direct USA, remembers that some early customers drove a couple of hours from their home in London, Ont., to ING's offices in Toronto just to make sure the operation was legitimate. "They wanted to know that we weren't some second-story boiler room," he says.

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Soon, technology let ING open accounts on the Internet. In 2000, ING introduced the first U.S. online high-yield savings account with no minimum balance and no monthly fees. Today, ING Direct USA, part of Dutch financial conglomerate ING Groep, has more than $62 billion in assets and is the fourth-largest savings bank in the nation -- and it doesn't have a single walk-in office, just a handful of orange cybercafes.

ING and other virtual banks can pay high yields with few strings because it is six times cheaper to offer savings online than at a fully staffed branch, Celent estimates. That leaves plenty of room for new-age banks to pay out more and still gush profits. Rivals here and abroad have noticed ING Direct's success. For example, London-based HSBC has opened HSBC Direct. Small U.S. banks, such as Cleveland's Ohio Savings Bank (through AmTrust Direct), and gigantic ones, such as Citibank and Washington Mutual, introduced high-rate online accounts to guard their flanks. Mortgage lenders, credit-card companies, insurers and brokerages have joined in to sell online banking services to existing customers.

If you receive a solicitation from an Internet bank, it may be worth reading. One-third of consumers who hold more than $10,000 in liquid assets in the bank never check rates on savings accounts, according to Forrester Research. "They have no idea about the amount of money they are leaving on the table by not moving their savings balances to a higher-yielding account," says Forrester analyst Catherine Graeber.

Nuts and bolts

When Amy DuBois opened her account, there wasn't as much competition. Now, the sheer number of choices can paralyze you. Bankrate.com, which lists more than 20 online banks that pay above-average yields, is a good place to compare accounts.

Cyberbanking is still banking, so some things don't change. With a certificate of deposit, you tie up your money but typically earn more interest than in a savings or money-market account. Money-market accounts have check-writing privileges, but you're often limited to just three a month. HSBC Direct, Citibank Direct and others issue widely accepted ATM cards, but some banks -- most notably ING Direct -- do not link to ATMs, so you cannot get cash easily. That means you may need to transfer money out of savings to a standard bank account.

Another annoyance is the time it can take a transaction to post to an online account. An initial deposit might take up to 15 business days to show up. However, subsequent deposits and transfers should post much faster.

DuBois is used to the two-day lag for most deposits to ING Direct, but, she says, "it's still a pain." Around the industry, it takes an average of three to five days before you can access new deposits. That should give you pause if youure eager to quit dealing with regular banks altogether.

More than CDs

Still, that radical step could be in your future. Software engineer Ing-Jye Hwang, 39, is thinking about going completely online and closing his local bank account. "I hardly use it," he says. Hwang, of Campbell, Cal., used to save at ING Direct before switching to Countrywide Bank for a higher yield. He pays bills from an online account at Ameriprise Financial, so he doesn't write many checks. If you use a lot of paper checks, find an e-bank that won't charge you extra to do so. Online banks' checking accounts often pay 3% interest, an excellent deal compared with interest-bearing checking at traditional institutions.

If you prefer to carry cash, be sure your account includes an ATM card and note the fees. EverBank provides a Visa check card with its checking account and doesn't charge you to tap any of the thousands of ATMs in the worldwide Visa/PLUS network, although the bank that owns the ATM will take a fee. EverBank will reimburse you up to $6 a month for ATM fees charged by other banks, however, so it pays to make fewer and larger withdrawals.

Note that, as with any bank account, you may run into nuisance fees. Some will ding you for a low balance. Imperial Capital Bank, for example, charges $15 for the month if your balance drops below $1,000 on any day.

Understandably, security concerns scare some customers away from cyberbanking. In 2002, regulators shut down NextBank -- the first Internet-only bank to be seized by the government -- because of its unsound lending practices. The online bank offered only credit cards and certificates of deposit of $100,000 or more. Customers lost $29.4 million in accounts that exceeded the insured limit set by the Federal Deposit Insurance Corp. Nevertheless, regulators say online banking is safe. Fraud is more likely to occur through traditional banking than online banking, says Michael Jackson, an associate director of the FDIC's Division of Supervision and Consumer Protection.

Federal guidelines that take effect this year will require you to enter more than a user name and password to access your online account. Many banks already go beyond the minimum security measures. ING Direct and Citibank Direct ask you to pick an image from a menu of pictures to unlock your account. If a thief were to steal your PIN, he or she would still have to know which image you had selected. E*Trade Financial guarantees that it will reimburse any money lost to fraud, but the bank declined to say how often customers invoke the promise. Most banks presumably would do the same.

About borrowing

To sustain eye-grabbing savings yields, e-banks need to turn around and lend money profitably. So don't expect them to ply you with the cheapest credit. There's more overhead in lending than in gathering deposits because lending depends on finding customers with good credit scores who borrow a lot, then repay steadily but leisurely. Borrowers demand more personal attention than savers do, says Madhavi Mantha, a Celent bank analyst. That means more staff. And banking examiners pay more attention to lending practices than to what banks pay for deposits.

Yet some bargains exist. Citibank Direct beats regular Citibank branches on some home-improvement-loan offers. But the introductory-rate discounts, which amount to two percentage points below the rate for Citibank's best customers, are not as wide as the gap in yields on savings.

The rise of online banking does not portend the end of traditional banking. Actually, just as virtual banking is coming of age, banks are building more and spiffier full-service offices. The personal touch will never go away. DuBois would consider ING Direct for a car loan, but not to finance a house. When she and her husband, Wyatt, bought their first home in March, they borrowed from Chase after a mortgage broker aided with the application. "I like the idea of person-to-person contact in dealing with such an important investment," says DuBois.

Beware these pitfalls

Fees. Many online savings and money-market accounts don't levy standard monthly fees, but they nickel-and-dime you with other charges. Pay close attention to transaction fees. Imperial Capital Bank takes $1 every time you use a branch to make a deposit to its online checking account. And read the rules about penalties for low balances or excessive ATM use.

Frustrating teasers. Some of the juiciest rates vanish after three months. For example, EverBank recently offered a 5.84% introductory rate for its money-market account, which falls to 4.32% after three months. That's still above the 3.45% average for money-market accounts, but teaser rates have a history of morphing into substandard yields.

System failures. In November, a small number of accounts at E-Loan, an online financial-services company, duplicated transfer requests. The company says it has corrected the problem and reimbursed customers who incurred fees as a result. Last July, some customers of online bank EmigrantDirect could not access accounts for several days.

Impersonal service. To be fair, glitches in online banking are rare, just as they are in online stock trading. But you do need assurance that if you call, you'll be able to connect with a human being who has the authority and skills to help you. Call customer service before you open an account for a sense of how the bank will treat you once it has your money.