Banks are constantly taking money from us throughout our daily lives. Banks are a business like any other. Everywhere around you, there are places to purchase things, places to put our money for investing or storage.
The constant for all of these purchases or investments is; The Bank. The Bank holds and uses your money for their investments as well. These are some ways that the Bank takes your money from right under your nose.
1-Lending Out Your Money At A Higher Interest Rate (net interest margin)
2-Fees For Services And Accounts
3-Interchange On Cards
4-Fractional Reserve Banking
Banks like any other business are there to provide a service, to make things easier for the customer, you. Whenever a business makes things easier for their customer based on whatever their product is, they want to be compensated, Banks are no exception. The Banks product is money, Buying, Selling, Loaning, Moving and Protecting money. In doing these things for us they offer us a service, a convenience but, they also expect to be paid.
One of the most common ways a Bank makes money is through creating loans or lending the money they have to consumers. The Bank gets the funds to lend out from you, the consumer and then lend your money out to another consumer for a higher interest rate than they pay you.
So imagine you have $10,000 in a High-Interest Savings Account making 1.5% interest per year. When I go into the Bank and I would like to get a loan to purchase a vehicle. The Bank will go through the credit process to check me and make sure there is a “reasonable” to “low-risk” investment in lending me money.
After I am approved for the loan the Bank can lend me your $10,000 at a rate of 6%. Therefore, your $10,000 that you have in the bank at 1.5% interest, the Bank will pay you $150 per year and I will pay $600 per year in interest from borrowing.
This will give the Bank a $450 profit from your money in a year, simply because you have that money in their Bank. This difference in profit is called the Net Interest Margin. In this scenario, it is 4.5%, 6% from my loan minus 1.5% from your interest in your account.
According to investopedia.com:
The average net interest margin (NIM) for American banks was 3.3% in 2018. That figure shows a slight rebound from a 30-year low of 2.98% in 2015. But the long-term trend has been more or less downward since 1996 when the average figure was 4.3%.
Now think about the Net Interest Margin on the Credit Cards that we all have and borrow money at a potential rate of 19.99%. The Margins Of Profit for Credit Cards are huge for Banks and other lenders. This Net Interest Margin is why Credit Cards are coming not just from Banks and Credit Unions now but other companies are starting to capitalize on providing credit to consumers, making it easier to borrow money.
Fees For Services And Accounts
Minimum Balance Fees
Minimum Balance Fees are fees subjected to accounts that do not hold a certain amount of funds.
This is an important fee to take note of and one that you should check for on all of your accounts. If you have Checking or Savings accounts with Minimum Balance Fees, it will be more beneficial for you to keep your balance above the threshold and take advantage of Compound Saving. Compound Saving being, lowering or eliminating a consistent fee or cost and having the difference add up over time with interest.
Some banks use different methods to determine when to charge for Minimum Balance Fees.
Minimum Daily Balance Fee
Some accounts use a Minimum Daily Balance Fee. If you have an account that uses this type of fee the balance is checked by the Bank/Lender daily.
To avoid getting charged a fee for using this account either keep your daily spending above the threshold or make sure to deposit money into the account and bring it back up above the threshold every day.
The account may use a Set Monthly Account Balance in which, if at any time during the month your account goes below a set amount the monthly service fee is charged.
Combined Account Balance
Some Banks use a Combined Account Balance to determine when to charge a service fee. The Banks take a total for all of your Checking and Savings Accounts. If the combined amount goes below the threshold amount a service charge gets applied.
Using this knowledge to your advantage can be easy. Either by making a phone call to your Bank or Institution and asking a few questions to determine if one of these methods is being used, or going onto their website and checking your account details. By making a quick phone call or checking your account details you will know how the Bank determines when to charge a Service Fee to your account. You can then set up a plan in your daily activities to prevent fees from happening.
The average Checking Account charges $13.58 per month according to moneyrates.com. Therefore, the average account holder spends approximately $162.96 a year in Service Fees as of Feb 2019. That is a large chunk of money per year to pay out of a Checking Account.
Simply by keeping your Bank Account above the Minimum Balance Fee and having the $13.58 compound in a Checking Account every month at a rate of 0.05%, you will have $1647.36 after 10 years.
Some Banks don’t use a Minimum Balance Fees on their accounts and just have a straight fee. Check with your Bank and consider your options. Perhaps, if you can’t eliminate the fees with your Bank it may be worthwhile to shop around for Checking Accounts with another Bank that offers free Checking Accounts.
Overdraft Charges occur when your accounts drop below zero and the Bank now has to cover your over expense on the account with Credit.
Typically, Accounts that have Overdraft on them have a set amount of Credit. The amount of Overdraft Credit can vary from $500 to $1000 or more at set Interest Rates. As well as receiving interest on the Overdraft Credit, Banks can charge a fee for the use of Overdraft.
Typically, the fee for using Overdraft is around $35, which is a huge fee that can be re-occurring if you are constantly using Overdraft Protection.
Benefits To Having Overdraft On An Account
Overdraft Interest Rates Are Lower Than Credit Cards Or Some Other High-Interest Loans.
Therefore, using Overdraft for short term loans to pay expenses can be a better option than a Credit Card. If in the long run, you are using Overdraft Protection a lot, the difference in interest charged can be very beneficial in making it easier to pay back the Overdraft in comparison to a Credit Card with a Higher Interest Rate.
Overdraft Provides A Protection For Your Daily Or Monthly Expenses.
If you are short on funds to completely pay for a bill, Overdraft will kick in and allow a bill to be paid whereas, without the protection, A cheque/expense would have “bounced” due to the Insufficient Funds being in the account.
Downsides To Using Overdraft Protection
Overdraft Protection Is Still A Type Of Credit.
It charges Interest and Fees to use it. It may be better to use Overdraft because it has a lower Interest Rate than Credit Cards but, there is still Interest being charged from borrowing the money from the Bank. Therefore, any expense will still cost more.
Overdraft Isn’t A Never-Ending Supply Of Money
You can still bounce Checks or Bills when too much Overdraft Protection is used. There are set amounts of Credit allowed.
NSF Charges (Non-Sufficient Funds)
NSF charges occur when money is trying to be taken from an account that doesn’t have enough funds to cover the expense. A lot of times this will happen with Automatic Withdrawn Bills or other expenses as well as Cheques.
When the Bank receives a Cheque from an account without sufficient funds to complete the transaction, the Bank can refuse the payment as well as charge the account holder a fee for having Insufficient Funds to complete the transaction.
If the account has Overdraft Protection the payment may still go through but in this case, there can be charges for using the Overdraft on the account to complete the transaction.
For example, if you had $150 in your Bank Account and wrote a Cheque for $180 a couple things may happen. One, the Bank will refuse payment and you will incur an NSF charge or Insufficient-Funds charge to your account, or the transaction will go through and your account will be $-30 to which you may still receive a fee based on the Overdraft the Bank used to complete your transaction.
Keys to Avoid NSF Fees
The best way to avoid receiving NSF fees is simply to budget your expenses and know when payments come out of your account properly. By knowing the total funds that are available in your Account you can make sure that you don’t leave your Accounts short and receive an NSF fee because of lack of funds.
You can also set up an Overdraft Protection Limit on your Accounts to have some security that even if you make a mistake on your Budget for that payment, the payment will still go through and get paid for.
This becomes especially important for some payments such and Insurance or Mortgage Payments. If you miss too many Insurance Payments due to NSF you not only will be charged fees from your Banking Institution but you risk losing your Insurance Provider.
Interchange On Debit and Credit Cards
You may ask well that’s weird, I don’t receive a fee for using my Debit or Credit Card. It’s not the consumer that directly receives these fees. Interchange Fees are fees the Banks or Payment Processor charge every time a customer uses a Debit Machine to complete a transaction. These fees are charged to the Company/Merchant that you purchase from.
The Banks use Interchange Fees to cover their Risk in the transaction such as Fraud and general Credit Risk. Also, these charges cover the expense of processing and approving the payments. Usually, Interchange Fees will show up as a single expense that the Processor gives the Merchant along with any other Fees.
The amount charged for Interchange on Debit and Credit Transactions changes based on the Company as well as outside factors such as Interest Rates throughout the year.
The average amount that the Bank receives per transaction will typically end up being around 2% of the purchase amount.
Fractional Reserve Banking
Fractional Reserve Banking is how Banks make most of their money. The process of Fractional Reserve Banking is simply, the Bank takes your Money when you deposit it into your account and then lends out available funds based on a Reserve Ratio.
A Reserve Ratio is the ratio of funds available to a Bank relative to the amount that the Bank has issued in Credit to customers. It works like this.
To explain this we are going to use a fake Bank, Johnson bank. In this Bank, you have $1000 in your Chequing Account. Simple so far.
We will assume Johnson’s bank is required to have a 10% Reserve Ratio, what this means is the Bank must keep at least 10% of their available funds in the institution and can lend out 90% as Credit/”Debt”.
The key here is, the Bank keeping your money and lending out money they create simply because they hold yours!
So when I go into Johnson’s bank and I want a loan. Because you have $1000 in your Bank Account, Johnson’s bank can loan me up to $900.
The $900 is 90% of the total funds you have in your Account therefore, they are within the 10% Reserve Ratio. But the magic is this. I get the loan for $900 and you still have $1000 in your Account. Johnson’s Bank just created $900.
If I then go to Johnson’s Bank and pay off my loan of $900 now the Bank has a total of $1900 simply by using your money as a reserve to lend me Credit.
This is how Banks and Institutions create money every single day. Now, compound that effect. There is $1900 in funds available at Johnson’s Bank, the process of lending and keeping the 10% Reserve Ratio continues creating more and more money all the time.
The Bank is and will always be a business. They need to make money just like any other business. Bank Fees and Interest Paid are great for the Bank and can be difficult to handle on the consumers’ end but there’s hope.
With some knowledge of how Banks take your Money and make Money, you can use that knowledge to lower Fees and Interest you have to pay to the Banks. By lowering all of our expenses we can all benefit with some extra cash each month. One step closer to Financial Freedom.
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