Bank accounts and how they work

A bank account is somewhere safe to keep money, a way to get paid, and a tool for paying others. Most Australians hold two kinds, and knowing the difference is the first step to making banks work for you instead of the reverse.

The two accounts almost everyone needs

• A transaction account: for everyday money. Your pay lands here, your card and payment apps draw from here. It usually pays little or no interest.
• A savings account: for money you are keeping. It pays interest, and the good ones pay bonus interest when you grow the balance each month.

Interest is the bank paying you for holding your money, quoted as a yearly percentage. On a savings account it compounds: you earn interest on your balance, and then interest on that interest. The investing topic shows how powerful compounding becomes over years.

A quick illustration of compounding. Suppose you keep $1,000 in a savings account paying an illustrative 5% a year. After one year you have $1,050. In the second year the 5% is calculated on $1,050, not $1,000, so you earn $52.50 rather than $50, and you finish with $1,102.50. That extra $2.50 is interest earning interest. Over a single year it is trivial, almost not worth mentioning. Over decades, as the investing topic shows, that same small effect compounds into the largest force in personal finance.

Why a bank pays you anything at all

It is worth understanding where that interest comes from. When you deposit money, the bank does not lock it in a safe and wait for you to return. It lends most of it out to other people as home loans and business loans, and charges them a higher rate than it pays you. The gap between the two is how the bank makes its money. So the interest on your savings account is really a small share of what the bank earns by lending your money on. This also explains why the rate is never generous: the bank is paying you the least it can while still attracting deposits, which is exactly why it pays to compare.

People picture their money physically sitting in the bank, waiting for them, and it is not. At any moment most of the deposits in a bank are lent out and working elsewhere in the economy, which is fine, because not everyone withdraws at once. This is also why the Financial Claims Scheme matters. It is the government's guarantee that stands behind your deposit even in the rare case that a bank itself fails.

What to look for, and look out for

Plenty of Australian accounts now charge no monthly fee, so there is rarely a reason to pay one, especially as a student. Watch for the quiet costs instead: ATM fees from machines outside your bank's network, international transaction fees, and savings accounts whose advertised rate needs conditions you will not actually meet. Read the conditions on bonus interest before believing the big number.

The catch on bonus interest is worth spelling out, because it is where the advertised number and the real one part ways. A savings account might show a headline rate that only applies in a month when you deposit a set amount and make no withdrawals, and grow the balance. Miss any one of those conditions, even once, and the rate quietly drops to a much smaller base rate for that month. None of this is hidden, exactly. It is written in the conditions, which is precisely why reading them is the difference between the rate you were promised and the rate you actually get.

Money in an Australian bank is also protected. The government's Financial Claims Scheme guarantees deposits up to $250,000 per person per bank, which is why a bank account is the safe place for savings while you learn.