What is a Sweep Account?
A sweep account is a type of bank or brokerage account that automatically transfers funds in excess of a certain amount to a higher interest-earning investment account. This transfer occurs at the end of each business day and may be done with an account in the depository (internal sweep account) or an external sweep account. One can use excess funds to repay loans.
How do sweep accounts work
A sweep account “sweeps” money between a checking account and an account that earns a higher interest rate.
When creating a sweep account, you choose a specific amount to retain in your checking account. Only funds in excess of this amount will be transferred at the end of the working day. This excess is transferred to investment options like money market accounts or high-interest savings accounts.
On the other hand, if your checking account balance drops below this level, the funds are reverted back from the investment vehicle to ensure enough funds in your checking account to avoid overdrawing.
Sweep accounts may also be used to repay loans in lieu of earning interest. The procedure remains the same, except that instead of putting the excess funds into an investment account, the excess amount in the checking account is used to repay the loan, thus making your debt payments easier and faster. However, if your checking account falls below a specified threshold, you won’t be able to repay the loan. In that case, you will have to use a line of credit to replenish your funds.
Example of a sweep account
Ayush holds an auto sweep account with a threshold limit of Rs. 25,000/-. The interest on Ayush’s checking account is 4%. As of 1st August, he has Rs. 20,000/- in his account.
Since his current balance is lower than the threshold limit of Rs. 25,000/-, the money remains in his checking account and earns regular interest at 4%.
On 20th August, he deposited Rs. 45,000/-, bringing his balance to Rs. 65,000/-, which is above the limit. So the surplus above Rs. 25,000/- that equals Rs. 40,000/- will be automatically transferred to an investment account on which he will earn interest.
On 25th August he withdrew Rs. 10,000/-, dropping the balance in his account to Rs. 15,000/-. His investment of Rs. 40,000/- remains intact.
On 30th August, Ayush wants to withdraw Rs. 25,000/- from his account. The balance in his account, i.e. Rs. 15,000/- is inadequate. So the sweep account will make a reversal for Rs. 10,000/- into his checking account.
What is the functions of sweep accounts?
Sweep accounts, for business or for personal use, ensure that money is not idle in a low-interest earning account, while it could very well be earning higher interest in distinctly liquid investment vehicles. These investment vehicles include money market mutual funds, high-interest investment or savings accounts, and short-term certificates with maturities ranging from 30, 60, or 90 days.
Some institutions offer an auto-sweep feature, where a sweep account is linked to a regular account and transfers start automatically when certain thresholds, both upper and lower limits, are crossed.
Businesses and individuals should keep a keen eye on their spending via checking accounts. The benefit of higher returns from an investment vehicle outside the checking account can be offset against any account fees charged. Many intermediaries or banking institutions charge a fixed fee, while certain others charge a percentage of your income.
The difference between personal sweeps and business sweeps
A sweep account for individual investors is commonly used to park funds waiting for reinvestment – incoming cash, money from dividends, and sales orders. These funds will generally be swept into high-interest accounts or into money market funds. This continues until the investor makes a distinct future move, or until the broker performs permanent orders in the portfolio.
Sweep accounts are well-known business tools, especially for small businesses that depend on working capital, but also want to maximize the potential of cash reserves. The business establishes a minimum balance for its major accounts, over which money is swept into better investment products. If the balance falls below the threshold, funds have returned to the account.
Depending on the institution and investment, the liquidation process is usually settled daily from the checking account, while refunds may be delayed. As checking account rules differ, some banking institutions also offer higher interest rates on amounts in excess of certain balances.
Advantages of sweep accounts
- Sweep accounts help you compound your money. Excess funds sitting idle in your checking account can be transferred to an interest-bearing account.
- They can be alternatively utilized to pay off debt. Instead of transferring the excess funds to an interest-earning account, a sweep account would sweep the surplus towards loan payments. The process is rendered smooth, convenient, and financially prudent.
- It provides the convenience of easy financial management. Sweep accounts help ensure interest earnings. Such accounts are also usually highly liquid, which means your money remains easily accessible. A sweep account is an easy way to let your money make more money, without another item on your to-do list.
Disadvantages of sweep accounts
- Sweep accounts may come with certain fees: Using a sweep account may likely entail charges or fees for investing that money. Before making significant decisions, always be aware of, as well as understand all of your account fees.
- Penalty charges: The chief disadvantage of sweep accounts remains the penalty charged, if any, on the premature withdrawal. In unfortunate cases, you may earn even less than saving bank interest due to the penalty.
Final word
The answer to what a sweep account is describes an account that moves extra funds, if any, between a checking account and a higher interest-earning investment account. This transfer occurs at the end of every business day. Sweep accounts can help you get more value for your (idle) money. The key is finding avenues that match your financial needs and goals.