How Do Banks Make Money?

People know that banks are good at making money. Financial companies like commercial banks, credit unions, and investment banks all make money in similar and different ways.

Even though the banking system can seem confusing, understanding how banks make money can help you understand what happens to your money when you give it to them.

What do banks do to make money?

Here are the most important ways that banks make money:

  1. Interest-Based
  2. Loans
  3. Investments
  4. Fees

1. Based on interest: The “spread”

Banks are great at making money work for people. Money is an advantage for a bank because it can be used to make more money. This is a good time to use the spread. Basically, it is the difference between what the bank makes and what it pays out.

When you put money into a bank account, like a CD or savings account, you might get APY, or annual percentage yield. This is what the bank will pay you as a proportion of your total deposits for keeping your money in the account.

Your money doesn’t just sit in a box somewhere. Instead, the bank uses it to get a return that is even higher than the APY it pays you.

The difference is called the spread, and it is one of the bank’s most important ways to make money. Let’s take a look at some ways this could work.

2. Loans

Many people open bank accounts to save money, but others borrow money from the bank to pay for big purchases like a house or a new car.

The bank doesn’t give the user the money for free; it charges an interest rate. Most of the time, the amount of interest is based on the amount taken and a few other things.

In 2019, the average interest rate on a mortgage was 4.75 percent. The average APY rate on savings accounts, on the other hand, was 0.05%. This means that the bank makes 4.70 percent on the money it lends. If you take away the 0.05 percent APY rate, the bank pays customers for giving it money.

Some banks do sometimes offer APY rates that are higher than 1% or more.If you choose a bank account with a higher APY rate, your account will grow even faster.

CDs, which are a type of bank account, also have interest rates that are higher than average, but you can’t take the money out until the CD matures.

3. Investments

The bank can also put the money to work in other ways that may give them an even better return. These different options can come with a lot more risk, but they can also pay off in a big way.

You don’t need to be worried about the safety of your savings. Banks have to follow the rules and can’t just spend without thinking it through first. This means that most of your money is still safe. This is very true for accounts that are guaranteed by the FDIC.

Federal Deposit Insurance Corporation is what FDIC stands for. It is part of the federal government, but it is still its own organization.

Depositors are usually covered up to $250,000 by the FDIC, but you should check with your bank before putting money in there.

4. Bank Fees

Banks also charge different kinds of fees that can help them make money on top of the money they give out. Depending on the services used, there are a few different fees. We will now talk about some of the fees banks charge to make money.

Maintenance fees

Many banks charge fees for bank accounts every month. Depending on the type of account, the monthly fees tend to be different. High-tier accounts tend to have higher fees than lower-tier accounts.

You get a lot for the money you pay in fees, which tend to be different from one bank to the next.

Still, there are ways to avoid having to pay these fees. In some cases, you can avoid fees by keeping a minimum amount in your account or by setting up direct deposits often. When you meet the basic requirements, there are many kinds of free checking accounts and free business checking accounts that you can open.

Some bank services, like credit cards, may also have fees that you have to pay every month. In particular, most credit cards have an annual fee, as well as other fees that we’ll talk about next.

You don’t have to pay these fees, and you can avoid them. Look for bank offers for new account holders that say you won’t have to pay any maintenance or annual fees if you do things like keep a minimum amount in your account.

Penalties

There are many reasons why many banks charge fees. Most of the time, you can avoid these fees, but many people end up having to pay some of them at some point in their lives.

  • NSF fees are paid when there aren’t enough funds in a checking account to cover a transaction.
  • Overdraft fees are what you pay when a bank pays for a transaction that costs more than what you have in your account. But if you sign up for overdraft insurance, you can often avoid this.
  • Late Fees: A fee that is charged when a payment is late.
  • Inactivity fees are fees that are paid when an account hasn’t been used in a certain amount of time.
  • Early exit fees are fees that you have to pay if you want to get your money out before the maturity date.

Withdrawal fees

Some banks also charge fees when you take money out of an ATM. This varies from bank to bank, and some banks don’t charge any fees at all.

Some banks will also work with ATM networks so that any of their cards can be used to get money out of an ATM for free.

Commissions

A lot of banks have ways to spend that can give you a better return than a savings account.

More and more people are choosing to invest in these ways, which are generally either self-directed or managed. In general, stocks, commodities, and other types of investing can be among these choices.

In either case, the bank will get a cut of the investments the customer makes. Most of the time, this is done through a spread (when it is self-directed) or a fee (when it is handled).

Fees for processing

When you ask for something, like a loan, many banks will charge you a fee.

These fees change from bank to bank, and some banks don’t charge them at all or give them back when the application is accepted.

Service management fees that are optional

The bank also charges its users some other fees. Even though many of these fees are for services that you don’t have to use, they can still bring in money for the bank.

  • This is especially true for banks with many users who all have different needs.
  • When a customer asks for a cashier’s check, they have to pay check writing fees.
  • Customers pay money order fees when they ask for a money order.
  • Interchange fees are what a store has to pay when a customer pays with a credit card or debit card.
  • Foreign currency exchange fees: The bank buys and sells foreign currency at different rates and gets a fee every time currency is swapped.
  • Wire transfer fees: When a customer sends a wire transfer, the customer pays the fees. Most of the time, this only applies to wire payments from one country to another.
    Please keep in mind that not all banks will charge these fees. Some banks might give certain services away for free to all account users or to people with higher-level accounts.

Interest on credit cards

Customers of most banks can also get credit cards. When an amount isn’t paid off in full by the due date, interest can add up quickly, and it’s pretty common for interest rates to be high.

How Do Commercial Banks & Credit Unions Make Money?

Both credit unions and private banks are important to the economy. Commercial banks offer different kinds of financial goods and services to both people and SMEs (Small and Medium Enterprises) like freelancers and small businesses.

Commercial banks can give any of the following products and services:

  • Looking at accounts
  • Certificates of Deposit (CDs) and savings accounts are examples of deposit accounts.
  • Bank loans
  • Credit card
  • Deposits
  • Investments
  • Cashier’s checks are used to pay for things.

These aren’t the only financial services that business banks provide, since different banks offer different services. This is especially true as banks add more services to their list to draw more customers.

Commercial banks make money the same way that credit unions do. Credit unions are different because they are not-for-profit companies.

Since they are not trying to make money, they can charge lower fees. Any money that credit unions make in profits is either put back into the credit union or given to its members as a reward.

Banks need to make money so they can keep offering services like savings and checking accounts, personal loans like car loans, and everything else.

How to keep expenses low

So, as you can see, banks do make a lot of money. But this doesn’t mean that you have to pay all the fees the bank charges. There are many ways to keep your costs low and even increase what you make from them. Among these are:

Find deals and offers from banks. Many banks have deals that can help you save money. You can find different bank deals and promotions that fit your financial situation, from free cash to higher APY rates.

Make payments on time. If you make payments on time, you can avoid a lot of the fees banks usually charge. If you have trouble making a budget, you could use software to keep track of what you spend.

Keep your credit score in good shape. It’s no secret that people with higher credit scores tend to get better deals from banks. If you want to pay the bank less money, keeping your credit score in good shape can help you do that.

Read More: Are Online Banks Safe?

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