How Do You Determine If Online Banks Are Safe?

[questions]

How can I be sure that the online banks are secure and not a scam?

How do I make deposits or withdrawals?

I like the fact they have 5.25% interest, but I'm scared since it isn't a place I can walk into.

[sweeps]

As discussed in this thread, if the bank is listed with the FDIC it's a good bet it's safe.

[Magicman]

PayPal.com offers a good rate and they are safe.

[catlinye_maker]

Paypal.com does offer a good rate, but it is a money market fund (at least the one I am familiar with) and is not FDIC insured; aka if the fund loses money (admittedly unlikely), tough. For truly safe money I would look for an FDIC insured savings account (check the list stickied to the top of this forum.) You can check Bankrate.com's safe and sound page for financial institution ratings and the FDIC's deposit insurance page to ensure that the online bank you are looking at is a good bet.

FWIW, I've been doing online banking for a while now, between the billpay service, the online savings, and the online access to my brick and mortar checking. There have been relatively few errors, and all were easily corrected.

EDIT: For me, deposits and withdrawals are handled by ACH (electronic funds transfer - not sure what the ACH stands for.) When I set up my online savings account, I gave them my checking account routing information. They made test deposits to establish the link, and now I go online, enter the amount I want transferred in or out and the date (and I can set up repeating transfers if I like) and they process the transaction. I use this system with several accounts, and most of them send me emails at each stage of the process: I get an email saying I've set up the transfer, one when it happens, one when the money has been taken from one account, and a final one when the money gets to the second account.

Hope this helps!

[sweeps]

I agree with cat, PayPal is an example of an online bank that I would consider not safe.

[tinapbeana]

ACH = automated clearing house

[disneysteve]

I agree with cat, PayPal is an example of an online bank that I would consider not safe.

Both Money and Kiplinger frequently list Paypal's MMF as one of the top-rated funds. I've read anecdotal reports of problems, but I find it hard to believe that they would consistently get such good ratings if the problems were that widespread.

And yes, I do keep some money with Paypal. Never had a problem. Very simple interface, good rate, plus I'm an active ebay seller so I use the same account for that business. Couldn't be easier.

[sweeps]

Paypal customer service is awful. If you have a problem, it can take a week just to get a response from a CSR and when you do, the CSR is often clueless.

Paypal is also quick to freeze your funds through no fault of your own. It can take a couple weeks to get your funds unfrozen. All this is based on personal experience.

These issues are reason enough to avoid them. The fact that there are better rates out there -- with banks that have FDIC insurance -- seals the deal for me.

[catlinye_maker]

I've got money (albeit a tiny amount) in a Paypal account myself, and am not really concerned about losing it. But the OP is looking for safe, and surely an FDIC insured account is safer than one that is not FDIC insured.

[Magicman]

I'm sorry if I caused a stir about PayPal. I thought that the poster was primarily concerned with his/her rate of return. I probably would not place a large sum of money with PayPal as an investment. They do however have a very competitive rate.

I don't use PayPal as my primary bank. If I were to recommend an online alternative to regular banking, I would say to open an account with an FDIC insured brick and mortar bank that allows you to transfer your funds electronically.

Thanks. I just wanted to clarify.

[disneysteve]

I'm sorry if I caused a stir about PayPal.

No need to be sorry. Money market mutual funds (MMF) are popular alternatives to bank accounts. In fact, this month's Money magazine recommended them as better choices than the high yield MMAs for folks looking for higher, more stable rates. They say if you are chasing the best yield for your cash, you should stick with money market funds instead of bank accounts. Their reasoning is that a bank regularly changes savings rates, "plumping them when it needs deposits and lowering rates when it doesn't." Money funds, however, closely track Fed moves.

Paypal is one MMF but there are dozens of others. For example, Vanguard's Prime Money Market (VMMXX) is currently paying 5.09%. One nice thing about many MMFs is that you can write checks on the account, usually with some minimum. With Vanguard it is $250. So you can keep a small amount in your regular checking account to cover small bills, but have the rest of your money earning a nice rate in an MMF and use that account to pay larger bills like car payments, mortgage, etc. The downside to MMFs is that they usually have a substantial minimum balance, like $3,000 for VMMXX, as opposed to many MMAs that have a $1 minimum, making them more appropriate for folks with smaller balances.

[Magicman]

Great information Steve, thanks for the explanation of Money Market Funds.

I wonder, do MMFs have the ability to offer higher rates because of the risk factor of their investments or the large "pool" of money they invest for their clients? Any thoughts?

As a side note, I have noticed the "plumping" of interest rate offers on savings accounts by banks. I think that most of it is promotional in nature also.

[disneysteve]

I wonder, do MMFs have the ability to offer higher rates because of the risk factor of their investments or the large "pool" of money they invest for their clients? Any thoughts?

I think they take very little risk. That's what makes them so safe, whether they are FDIC insured or not. To use VMMXX as an example again, 100% of their holdings are rated A, Aa or Aaa, and 97.3% are the top 2, Aa and Aaa.

MMFs invest in high-quality, primarily government issues with short maturities, typically less than 90 days.

As for Paypal, they don't actually manage the money deposited with them. They simply collect it and turn it over 100% to Barclays Global Fund Advisors. Paypal is just the middleman, maintaining the account.

[Magicman]

Thanks once again for the great insight, Steve. I see now how they offer security and a higher rate of return at the same time.

[sweeps]

Sorry to butt in, but how exactly does a money market fund offer more security and a higher rate of return than online savings accounts?