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Your bank may have paid you $150 in a year’s time but they earned hundreds or thousands
more from the interest on loans (made possible with your money). Now, think about this process
repeated with millions of banking customers and billions of dollars.
Fees, Fees, Fees
Yes, banks make a lot of money banks from charging borrowers interest, but the fees banks
change are just as lucrative.
Account fees. Some typical financial products that charge fees are checking accounts,
investment accounts, and credit cards. These fees are said to be for “maintenances purposes”
even though maintaining these accounts costs banks relatively little.
ATM fees. There will be times when you can’t find your bank’s ATM and you must settle for
another ATM just to get some cash. Well, that’s probably going to cost you $3. Such situations
happen all the time and just mean more money for banks.
Penalty charges. Banks love to slap on a penalty fee for something a customer’s mishaps. It
could a credit card payment that you sent in at 5:05PM. It could be a check written for an amount
that was one penny over what you had in your checking account. Whatever it may be, expect to
pay a late fee or a notorious overdraft fee or between $25 and $40. It sucks for customers, but
the banks are having a blast.
Commissions. Most banks will have investment divisions that often function as full-service
brokerages. Of course, their commission fees for making trades are higher than most discount
brokers.
Application fees. Whenever a prospective borrower applies for a loan (especially a home loan)
many banks charge a loan origination or application fee. And, they can take the liberty of
including this fee amount into the principal of your loan—which means you’ll pay interest on it
too! (So if your loan application fee is $100 and your bank rolls it into a 30-year mortgage at five
percent APR, you’ll pay $94.40 in interest just on the $100 fee).
Recently, banks are taking a lot of heat for interest rate hikes and fees going out of control.
Giving banks business may seem like putting yourself in harm’s way, but of course, it still beats
hiding your money under a mattress. Understand how banks work, however, and you’ll know
where to lookout for fees and how to avoid lining banks’ pockets by paying more interest than
you’re earning.
How do banks make money?
Banks are just like other businesses. Their product just happens to be money. Other businesses sell
widgets or services; banks sell money -- in the form of loans, certificates of deposit (CDs) and other
financial products. They make money on the interest they charge on loans because that interest is
higher than the interest they pay on depositors' accounts.
The interest rate a bank charges its borrowers depends on both the number of people who want to
borrow and the amount of money the bank has available to lend. As we mentioned in the previous
section, the amount available to lend also depends upon the reserve requirement the Federal
Reserve Board has set. At the same time, it may also be affected by the funds rate, which is the
interest rate that banks charge each other for short-term loans to meet their reserve requirements.
Check out How the Fed Works for more on how the Fed influences the economy.
Loaning money is also inherently risky. A bank never really knows if it'll get that money back.
Therefore, the riskier the loan the higher the interest rate the bank charges. While paying interest may
not seem to be a great financial move in some respects, it really is a small price to pay for using
someone else's money. Imagine having to save all of the money you needed in order to buy a house.
We wouldn't be able to buy houses until we retired!
Banks also charge fees for services like checking, ATM access and overdraft protection. Loans have
their own set of fees that go along with them. Another source of income for banks
is investments andsecurities.
You may not realize it, but banks are just another kind of business. Like all businesses, they can differ
in size, overall function and level of success. Nonetheless, they do share one thing in common. Banks
need to make money to continue operating.
Most commercial banks make money in three ways. First, the majority of revenue comes from
accepting deposits from consumers and then lending that money, with interest, out to individuals and
businesses in the form of bank loans. You are most likely very familiar with the fact that banks also
make money by charging fees. Additionally, banks even earn returns on investments they make.
Below is an explanation of how banks accomplish these methods of producing revenue.
If you want to make a withdrawal from your checking account, the bank must provide it to you right
then (hence the common term, “demand” account). This means that the bank must maintain enough
cash on hand for customers to access their account funds at any time. On the other hand, when you
commit to an investment period of several months or years, the bank can loan money out without you
needing it for a while. You are usually rewarded for helping the bank earn more money from interest
payments by receiving a higher interest rate yourself.
How does a bank profit from interest they collect when they pay you interest too? Consider this:
Yourmoney market account of $50,000 with a 1.25% APY earned you an extra $625 this year. That’s
great. Your bank loaned out your $50,000 for part of a home loan, plus much more from other
depositors, and collected several thousand dollars in interest payments. That’s great for your bank as
well.
Bank Fees Add Up
Interest alone does not make up the sum of a bank’s profits, however. The fees a bank charges in the
form of services and penalties also attribute to a large portion of their revenue.
Consider all of the fees you have paid over the years. Banks charge monthly service fees for
maintaining an account, withdrawal fees when you use an ATM from another bank, application fees
for obtaining loans, and numerous penalties for overdrawing, bounced checks, etc. The list goes on.
While none of these individual fees are considerably large, though you may have lost an hour’s pay or
more to one, the sheer number of charges that occur every day adds up to big bucks.