Laura Rowley Money & Happiness

Over the last two years, community banks and credit unions offering checking accounts with interest rates as high as 5 percent have proliferated across the country. The rates are far superior to returns offered by traditional savings accounts and certificates of deposit, and since the accounts are FDIC-insured, they're a conservative place to park cash. But account holders have to jump through a number of hoops to earn that high interest, sparking a debate over whether they're worth the effort.

Often known as "Reward Checking," the accounts are free with no minimum balance and they provide refunds for fees incurred by using other banks' ATMs. Interest rates are currently as much as 4.5 percent annually for account holders who meet certain criteria -- typically 10 or more debit transactions a month, use of online bill pay, an ACH transfer and/or direct deposit and receipt of account statements by email. Institutions cap the amount of money that can receive the high interest rate to a maximum of $25,000 to $50,000.

Banks can offer juicy returns because the account requirements reduce processing, printing and mailing costs, and the debit transactions generate interchange revenue. But account holders who fail to meet the rules receive no interest on their balance for that month, or a nominal rate, typically less than 0.5 percent.

BancVue, an Austin, Texas-based software company, is the backbone of the vast majority of the high-interest checking accounts provided by small banks and credit unions. The firm has 700 institutional clients with a combined $12 billion to $13 billion in high-interest checking deposits. BancVue monitors and analyzes the profitability profile of each customer within the institutions to ensure the accounts offer enough profit to the bank to justify the high rates of interest.

Deposits are growing, says BancVue Chief Executive Officer Gabriel Krajicek. Over the last 12 months, the average balance in a reward checking account increased by $2,000. "How much of that is money leaving credit card accounts or mega banks or the stock market is hard to track," he says. "But we think that has a lot to do with dissatisfaction people have with the mega banks, and frustration with credit card reward programs that aren't as attractive as they used to be."

Meeting the Minimum

But at least one community banking executive calls the accounts a gimmick, because the institutions won't make money if all of its customers follow the rules. "Our view is that they are luring people in with potential high interest, but the only way banks make money is when customers don't meet the standards," says Steve Jones, executive vice president retail banking at Riverbank, which has seven branches in northeastern Massachusetts and southern New Hampshire.

Riverbank offers a free checking account with 0.5 percent interest, 5 to 10 cents cash back for each debit-card transaction and up to $15 in ATM rebates. Jones says his firm considered adding higher-interest checking accounts a few years ago. "The only way we would make money is if about one-third of customers didn't meet the standard in a given month," he says. "We don't believe in making money by having customers screw up."

Krajicek bristles at the description. "That's absolutely ridiculous; it's not how the account works," he says. "The account life expectancy is twice as long as free checking. There's no way you would have dramatically lower attrition if all you were doing is screwing the customer. Customers pick up on that, they are smart and they'll go somewhere else. It's not hard to use a debit card 10 times -- everyone goes to get gas, to the grocery store or out to eat a few times a month. And if you choose not to do those things, what's the penalty? There isn't one -- it's a free account."

And therein lies the rub: For some consumers, it actually is a challenge to do 10 debits in 30 days. These accounts tend to work best for younger consumers, says Greg McBride, senior financial analyst with Bankrate.com. "Younger people would sooner leave without their car keys than their debit cards, so it's a good fit there," McBride says.

The accounts may also provide a solution for consumers who typically use their credit cards to earn rewards and pay in full each month -- but are in the market for a mortgage or other loan. The higher the credit score, the better the interest rates consumers receive on loans -- and consumers with the highest scores utilize less than 10 percent of their available credit. So it makes sense to avoid stacking up expenses on credit cards for the sake of miles, cash-back or other rewards. (Example: If the limit on all of your credit cards totals $10,000, you should charge no more than $1,000 on them in a given month, paying them off in full.)

On the other hand, McBride says, "if the debit card is a learning curve because you haven't been transacting that way, these accounts probably aren't going to work as well for you. Changing your habits to make purchases with debit instead of credit for the sake of garnering the higher interest rate might be tough. If the account requires using your debit card 10 times per month and you only use it nine, you'll fall well short of that 4 percent rate you'll earn."

Moreover, consumers switching from credit to debit transactions aren't used to having the money withdrawn from their accounts immediately, which could lead to overdraft fees if they maintain a low balance.

Getting the Top Rate

Krajicek says reward checking accounts do not have statistically higher non-sufficient funds (NSF) revenue. "We are not systematically driving up NSF revenue in reward checking versus free," he says. "That is not a component of this account that we actively work to enhance."

I recently opened a high-interest checking account at an out-of-state bank, while maintaining my local free checking account. I put a portion of my emergency fund up to the maximum that could receive 4 percent interest, and I make a monthly deposit to cover specific expenses -- the mortgage, groceries and dining out. Because it's an ample chunk of change to expose to debit-card fraud, and presumably the risk is higher because I debit so frequently, I monitor the account online every day. If thieves steal your credit card, you can protest the charges and refuse to pay them; if they pinch your debit card and pin number, say sayonara to your cash -- and bonjour to the hassle of getting it back. (In next week's column, I'll provide a dozen ways to protect your account from debit-card fraud.)

McBride says the accounts are ideal for savers trying to beat inflation. "Many of these accounts have caps of $25,000. That's the maximum (on which) you can earn that high rate of return, so a lot of people are parking a good chunk of change in there," he explains. "You want to maximize the amount of money earning that top rate and minimize the dollar amount of purchases, but do it often enough to clear the hurdle to (qualify for) the top rate. It's not going to work for someone who has trouble limiting their spending or who is not a saver."
 
You can find one of the high-interest checking accounts powered by BancVue at CheckingFinder.com. Search by state -- if having a local branch is important to you -- or by highest return. More than 70 percent of the site's users are looking for a local institution, says Krajicek.

"The whole spirit of the account is that you should have your primary relationship with the bank," he says, adding that people who are gaming the accounts are "a very small percentage of total population."