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Online banks vs. traditional banks: Key differences — and how to choose what's best for your money

Online banks vs. traditional banks (Ridofranz via Getty Images)

Americans already do most of their banking online — at least 7 out of 10 U.S. households are enrolled in digital banking, according to a recent survey on digital financial literacy, with 95% of those enrolled saying they bank online occasionally or often.

If you’re using your bank’s app to pay bills or check balances, transitioning to an online-only bank might save you more money on fees, get you stronger returns on your savings and increase access to your cash through an international network of ATMs. But even if that’s not the way you’ve done your banking in the past, your willingness to learn how to use those tools could give you access to all the benefits that online banks have to offer.

Still, online banking isn’t for everyone. While a recent J.D. Power study reveals that customers of online-only banks are more satisfied overall than those of traditional banks, not all digital institutions get stellar customer service scores — especially when the problem’s complex. And with your entire banking experience revolving around a website and mobile app, when those tools are glitchy or change for the worse, customer satisfaction scores can slip.

So, if you’re interested in exploring your online options, here’s what to know and how to get the most out of your new bank.

An online bank works like your everyday bank, only without the network of physical branch locations you'll find with Chase or Capital One. With an online bank, everything is done through your computer, phone or smart device — from opening your account, to setting up your login details, to managing your money.

You might already be familiar with online banking, because most traditional banks support websites that allow you to check your account balances, transfer money and pay your bills online. Many also support mobile apps through which you can deposit checks using your phone’s camera.

While it may not matter to you whether your bank or credit union supports branch locations, it can matter a lot when it comes to the interest you earn and the fees you pay. Online banks don’t have the same kind of overhead required to keep branches and networks open, and they pass on those savings to their customers in the form of significantly higher yields on deposits and investment accounts — and lower or even no fees when compared to brick-and-mortar banks.

Online banks also tend to offer more robust mobile apps and websites with features like online budgeting, savings buckets and account alerts, among other useful tools. And just like with a traditional bank or credit union, your deposits are insured up to $250,000 by the Federal Deposit Insurance Corporation (FDIC) or National Credit Union Administration (NCUA).

Dig deeper: High-yield accounts vs. traditional savings account: Why it’s worth the switch

Online banks and credit unions work similarly to their traditional counterparts, often because they partner with larger financial institutions. You set up a username and password for connecting to your accounts through a secure website, online banking portal or mobile app to view your balances, transfer money between accounts and conduct other tasks related to your finances.

In fact, some online banks are just the digital arm of a traditional bank. For example, Liberty Bank started online-only Owners Bank to focus on small business accounts, and American Commerce Bank opened the online-only Monesty Bank with a focus on financial security and account alerts to stop fraud.

Upgrade is an example of an online bank that partners with Cross River Bank, which supports physical branches in New York and New Jersey. But online banks like SoFi and Ally are large enough to not require partner banks.

A bank’s affiliations can be found in the small print near the bottom of its website, including whether it's a division of another bank or the specific bank services offered through its banking partners. That small print will also confirm the bank’s deposits are insured through FDIC or NCUA.

Example of Upgrade’s bank affiliation statement, courtesy of Upgrade
Example of Upgrade’s bank affiliation statement, courtesy of Upgrade (Upgrade)

As you decide whether online or traditional banking is right for you, consider these perks of an online-only bank account.

  • Higher rates and lower fees. Online banks save a bundle without operating branch locations, and these savings translate into stronger APYs on high-yield savings accounts, checking accounts, money market accounts and investment products like CDs and IRAs. Many digital banks also commit to no-fee accounts supported by innovative budgeting and financial planning tools in banking apps for managing your money and strengthening your digital literacy.

  • On-the-go banking. You won’t need to wait in a teller line or drive-thru ever again. With an online bank, you can pay bills on your laptop while watching a movie or deposit a check in your PJs at the breakfast bar with a few swipes on your phone or tablet.

  • Perks that save time and money. You may miss the days of free toasters for opening an account, but some online banks offer useful perks — like access to direct deposits up to two days early or free cellphone protection coverage in exchange for paying your mobile bill with your debit card.

  • Round-the-clock customer support. Not all online banks are created equal, but many offer customer support that’s open 24/7. And if you’d rather avoid soft jazz on hold while you wait for the next available representative, many banks also support live chat, texting or in-app messaging for help.

  • Access to wide ATM networks. With most online banks, you won’t need to hunt down a location near you to take out cash. Rather, many partner with nationwide (and sometimes international) networks of ATMs that you can use for free — and they might even reimburse your out-of-network fees.

Online banking comes with its share of drawbacks too. Consider the following downsides before opening a new account.

  • No in-person service. If you’re used to clearing up issues by walking into your local branch, this can be a deal-breaker. Online banks offer several ways to get your questions answered — just make sure to read customer reviews and complaints before opening an account. With no in-person alternative, you want to be sure you’re working with a bank that gets high customer service scores from its clients.

  • Limited banking services. Online banks might not offer the wide range of accounts you'll find at a neighborhood branch. If you like to keep valuables in a safe deposit box or exchange currencies with your home bank, you'll need to find an alternative for these in-person services.

  • No community outreach. Local banks and credit unions understand the needs of the areas they service. They might encourage employees to volunteer in the community or sponsor charity events and art festivals. It doesn’t help your bottom line, but it can make difference in your backyard.

  • Requires digital literacy. You don’t need to be a computer whiz to manage an online bank account, but you should be comfortable enough with the internet and phone apps to manage your banking online.

  • Cash deposits are tricky. If your earnings tend to come as cash — whether tip money, bonuses or consulting fees — your options for deposits are limited. Some online banks partner with third-party services like Green Dot that allow you to deposit cash onto your debit card or write a check for cash at more than 90,000 retailers like Walmart and CVS. Though while your bank may not charge for the convenience, the retailer can charge as much as $5.95 per transaction.

There’s no definitive best when it comes to online versus traditional banks. Instead, it could make sense to take advantage of both.

If you prefer an in-person touch for your day-to-day banking needs, a local branch can offer the perks you need while you take advantage of online-only high-yield accounts to boost earnings on your savings. Or maybe you never want to stand in line at a teller window ever again but like an easy way to exchange your currency before international trips.

If so, you can open a free account at your local bank with a minimum deposit and then find your best online-only match at the highest rates to grow your money faster.

Dig deeper: 7 best bank accounts for older savers, seniors and retirees: Our editor's picks for fees, rates, perks and more

Learn more about digital banks and online accounts when looking for the best fit with your budget and financial goals.

Digital banks use secure sites and mobile apps to support banking transactions, like monitoring deposits and payments and moving money between accounts. Fintechs — derived from financial technology — use a lot of the same technology with a focus on improving the traditional financial industry by finding gaps and streamlining services.

Fintechs can be FDIC-insured charter banks or partner with traditional banks to offer, for example, deposit insurance and other basic banking protections. Look for terms like "member FDIC," "FDIC insured" or "NCUA insured" when comparing your options.

Yes, online banking is as secure as other types of banking. Online banks use cutting-edge technology and encryption software that keeps your money and accounts safe. They often require multifactor authentication — a process of confirming you are who you say beyond usernames and passwords, asking you to answer personal questions or provide your fingerprint, for example — as well as monitor your account for fraud, alerting you to suspicious activity through your online account or banking app.

As with your traditional or everyday bank account, you can minimize scams, fraud and ID theft by keeping to a few key steps:

  • Monitor your account regularly. If you see something out of the ordinary in your transactions or statement, contact your bank as soon as possible to open an inquiry.

  • Don’t share your password or account details. Banks will never ask you to confirm or provide passwords or PINs over the phone or through email. If you receive a suspicious call, hang up and call your bank’s customer service line. Avoid clicking links in emails that say they’ll connect to your bank — instead, type your bank’s URL in a fresh browser tab and sign in with your username and password.

  • Don’t use public Wi-Fi to bank online. It’s best to avoid financial transactions on public networks, hotspots or other shared networks — even if they require a password. You never know who else you’re sharing your info with.

Heather Petty is a finance writer who specializes in consumer and business banking, personal and home lending, debt management and saving money. After falling victim to a disreputable mortgage broker when buying her first home, Heather set on a mission to help people avoid similar experiences when managing their own finances. Her expertise and analysis has been featured on MSN, Nasdaq, and Finder, among other financial publications. When she's not breaking down the complexities of finance, she's a young adult mystery writer of an internationally acclaimed series — and counting.