An interest bearing checking account is a checking account that generates interest income on the available balance in the account. The minimum balance requirements are usually higher for interest bearing checking accounts, and there are often fees charged when the account balance drops below the minimum balance required. Typically, the interest rate earned is much lower than Certificates of Deposit and even regular savings accounts. This is due to the liquidity of a checking account. The more liquid an investment is, the lower the rate of return on that investment.
The function of an interest bearing checking account is to provide the necessary liquidity of other types of checking accounts while paying interest on the available balance in the account. Interest bearing checking accounts give the account holder check writing privileges and encourage account holders to maintain a high balance in the account in order to generate more interest income.
The term "interest bearing checking account" is something of a misnomer in the United States, as it is technically illegal for a Federal Reserve member bank to pay interest on a checking account. Though these accounts are widely known as interest bearing checking accounts, they are actually Negotiable Order of Withdrawal (NOW) accounts. Also, money market accounts are often considered interest bearing checking accounts. This is only true to the extent that they pay interest and allow the account holder to write checks. They are not, however, FDIC insured like a checking account at a bank.
Interest bearing checking accounts can be a good idea if someone has several thousand dollars that they need to keep liquid but don't necessarily need to use immediately. However, the interest generated in an interest bearing checking account is nominal at best. According to Bankrate.com, the average yield on an interest bearing checking account over time is two percent or less. Additionally, there are minimum account opening and balance requirements that can amount to thousands of dollars.
Interest bearing checking accounts are something of a loss leader for banks, and they are used by banks primarily to generate relationships with new banking customers. In an effort to limit their losses, banks have begun to institute maximum balance limitations in addition to minimum balance requirements on these accounts. Though not every bank imposes a maximum balance limitation, this policy is quickly becoming the industry norm.
In a rising interest rate environment, interest bearing checking accounts offer better yields. Though they never attain the yields of savings accounts or Certificates of Deposit, they can pay a respectable annual yield when interest rates are higher than they've been thus far in the 21st century.