Since March 2020, bank interest rates throughout the UK have been at some of the lowest levels ever seen.
This is primarily down to the Bank of England, the UK’s central bank, who set a “base rate” that’s responsible for determining interest rates across the economy. From banks to mortgage lenders, nearly all financial institutions use the base rate to determine their own rates of lending.
However, the base rate has been below 1% since March 2009, and even fell to a historic low of 0.1% in March 2020 as the Bank of England attempted to shore up the economy amid the uncertainty of the Covid-19 pandemic.
As a result, you may now be shopping around for a savings account with the best rate for your money. If you are, then you may want to consider opening a savings account with an online-only bank.
Online or mobile banking has become incredibly popular over the past few years, with many online-only banks now successfully challenging traditional savings accounts.
In fact, one of the main reasons that online banks have managed to disrupt the banking space so much is because they can generally claim to offer higher interest rates than high street “brick and mortar” banks.
But why do online banks have higher interest rates? And does that mean that an online bank is more suitable for your savings than a traditional brick and mortar bank?
In this blog, I’ll explain everything you need to know about online savings accounts and interest rates, as well as some of the pros and cons of saving with an online bank.
Why do banks pay interest rates?
In general, banks pay interest as a small reward to encourage savers to deposit money with them.
Banks can make a lot of money by lending their customers’ money in the form of loans and mortgages, generating profits from the resulting interest that they apply to these loans.
That means the more savers who keep their cash with a bank or credit union, the more that institution has available to lend. This gives them the opportunity of making even more money.
Of course, what this also means is that there will be times when it isn’t that attractive for banks to have your money, as it costs them more to hold it in cash than they’ll be able to produce in profit.
As a result, a low interest rate may be indicative of a bank that doesn’t actually want your money.
Do online banks have higher savings rates?
In general, online banks offer better interest rates than high street banks.
Let’s take a look at a selection of current interest rates on some online accounts and on some traditional savings accounts from high street banks, as of 22 October 2021.
Winner of the Best Current Account Provider award in the 2020 British Bank Awards, Starling Bank is a highly popular online bank in the UK.
Since 1 July 2021, interest on Starling’s Personal and Joint Current Accounts has been 0.05% up to £85,000.
However, there’s no more interest available on any money you hold above this amount.
Monzo is another popular name in the online banking sphere, offering multiple accounts including personal and business savings accounts.
Typically, rates on savings are around 0.1%, although if you’re willing to lock your money in Monzo’s fixed savings account for up to 12 months, you could earn up to 1.07% interest.
Having started out in 2015 as a money transfer and exchange app, Revolut now has 15 million personal customers using them for various transfer and banking needs.
Revolut offers various interest rates across its main accounts, with interest rates ranging from 0.15% to 0.65% AER.
Bear in mind that other than the Standard Account, you may have to pay a monthly fee to save with Revolut.
Atom launched in 2014 as the UK’s first app-based bank and has cemented itself as a popular choice in the market.
Atom’s Instant Saver pays an interest rate of 0.5%, while rates for their range of Fixed Saver accounts range from 0.2% up to 1.45%.
High street banks
One of the biggest global names in banking, Barclays has around 48 million customers worldwide.
In the UK, interest rates on a basic account such as their Everyday Saver offer 0.01% AER. Meanwhile, the Blue Rewards Saver offers up to 0.15%, provided that you meet certain withdrawal criteria.
HSBC is another hugely successful global bank and is highly popular in the UK.
The rates you can expect to pay with HSBC vary widely, depending on whether you have a basic savings account, such as their flexible saver, or a high-yield savings account, such as their MySavings account.
As of 22 October 2021, these rates currently span from as low as 0.01% up to 2.47%.
Their Digital Regular Saver pays up to 3% interest on balances of £1 to £1,000, falling to 0.01% on any value over this amount.
Meanwhile, NatWest’s Premium Saver account offers just 0.01% interest, with an added 0.04% bonus for certain savings amounts if you don’t make any withdrawals in a month.
Online bank rates may not always be lower
As you can see, interest rates vary widely across these different institutions. A basic account with an online bank often appears to beat the rate of a traditional bank, while other accounts can vary.
However, this isn’t the case for every account. There are three key reasons why online banks won’t necessarily have the lowest interest rate all the time.
1. High-yield savings accounts
Firstly, brick and mortar banks might offer different types of accounts to online banks, making it harder to compare the two.
For example, an easy-access online savings account may pay more interest than the high street equivalent. But that same high street bank may also offer a separate, high-yield savings account product that pays more in interest.
You can see this in the information above, with some of HSBC’s accounts offering rates of up to 2.47%.
As a result, it wouldn’t be totally accurate to say that online banks will always pay you more interest.
Bear in mind that some high-yield savings accounts may require you to meet certain criteria, such as minimum deposits each month.
2. Interest rates change regularly
Secondly, interest rates are constantly in flux. Banks regularly update their interest rates in response to economic changes, including changes to the Bank of England’s base rate.
This is true for both a traditional bank and an online bank, meaning you can only really say which account or provider is offering the best rate at a particular point in time.
Please note that your bank will never change an interest rate that you benefit from without informing you in advance first.
3. Money market accounts
Another reason that an online bank may not outcompete a brick and mortar institution is that they don’t typically offer a “money market account”.
Offered by banks and credit unions, money market accounts are a type of high-yield savings account, often having higher interest rates than standard savings accounts.
However, they may also come with withdrawal limits, depending on which kind of account you hold and with which provider.
Even so, they still often come with a debit card or even some form of check-writing privilege.
This may make them more suitable for your needs than an account with an online bank.
Why do online banks pay more interest?
There are a few different factors that have led to online banks typically paying higher interest rates than traditional, brick and mortar providers.
As I mentioned above, your money isn’t that attractive to most banks at the moment in a low-interest environment. This means there’s little incentive for traditional banks to offer you competitive interest rates.
Traditional banks also have many years of building a successful brand that people trust with their money. Therefore, there’s less pressure on them to offer the best rates, as their name alone is often enough to convince savers to open an account.
By contrast, for online banks trying to attract customers, an improved interest rate can be a great selling point. While these banks may not have the supposed pedigree of the traditional offerings, a better interest rate means you can get more for your money.
As a result, online banks offer better rates to encourage new customers to sign up with them, or even to switch to them from one of the bigger names.
Fewer physical locations
One of the main factors that allow online banks to be cheaper is that they typically have few or even no physical locations.
Space is one of the biggest costs for banks but, by removing the costs of offices, these savings can be passed on to customers in the form of improved interest rates.
Limited customer support
Similarly to having fewer locations, online banks tend to streamline their customer service offerings.
Online banks often prioritise the quality of their website FAQ sections or web chat service, rather than having individuals in branches or on phones to answer questions.
Again, this allows online banks to save money, which they’re able to pass on to their customers with more favourable interest rates.
Which online bank is the best?
There are various factors to consider when choosing an online bank.
Whether you’re simply targeting the highest annual percentage yield (APY) on your savings accounts, you’re looking for a business account, you need a loan or mortgage, or you want to transfer money around the world, each online bank offers a different range of services.
As a result, the best bank for you will depend on your individual needs.
Our top picks include:
- Starling Bank
- Cashplus Bank
You can find out more about the different services that these banks offer in my guide to the Best Online Banks UK to help you find the best online savings accounts for you.
Are online banks better than brick and mortar banks?
By and large, knowing whether online banks are better than traditional high street options comes down to personal preferences.
Below is a quick summary of the main pros and cons of choosing an online bank.
Alongside their higher interest rates, there are other key benefits to choosing online banking.
Easy sign-up processes
Opening a bank account with an online bank can be straightforward as the process tends to be entirely online.
The ability to open an account online quickly and easily is a great feature, removing the stress of excess paperwork or having to go to a physical location.
Many online banks don’t charge monthly service fees, account fees, or monthly maintenance fees for their basic accounts.
In combination with superior interest rates, this means you receive more for your money compared to traditional banks offering lower interest rates with potential fees.
As online banks operate entirely in the digital space, they have some of the most comprehensive safety measures available for keeping your money secure.
From fraud-detection technology to two-factor authentication and session time-out, online banking services can be one of the safest ways to hold your money.
You can read more about how safe online banks are in my previous blog.
On the other hand, despite these advantages, online banks do still come with some downsides.
Difficult to deposit cash
As online-only banks don’t have physical locations, this means it can be harder to deposit cash.
Some online banks, such as Starling Bank, do allow you to deposit cash at Post Office branches. However, this may not be as convenient for you as the ability to deposit money directly at a bank.
Limited customer support
Another issue with online-only banks is that their customer support services can be more limited than brick and mortar banks.
While you can use FAQ sections or live chat services on websites, not being able to speak to someone can be frustrating and worrying, especially as it involves your money.
Meanwhile, if you really needed help, the ability to go into a traditional bank branch and ask questions can be useful and reassuring.
Online banks and regulation
It’s almost impossible to enter the banking space without regulation these days but, even so, you should check that any bank you choose to hold money with is authorised and regulated to do so.
You should always check that your bank is on the Financial Conduct Authority’s Financial Services Register on their website.
It can also be reassuring to know that your money is protected by entities such as the Financial Services Compensation Scheme (FSCS) in the UK or the Federal Deposit Insurance Corporation (FDIC) in the US.
These schemes can pay back a portion of your savings in the event that your bank goes bust and is unable to do so.
Knowing your money is FSCS protected (or FDIC-insured in the US) can give you greater confidence in your savings.
This blog is for information only and does not constitute financial advice. All interest rates included are as of 22 October 2021 and are subject to change.
Antonia is the Financial Editor at InvestingReviews.co.uk and brings a wealth of experience, having written for various industries over the past 10 years.
Her investment platform reviews, news, blogs and guides are meticulously researched, fact checked, and updated on a regular basis.