Cash News
Banks offer several financial products and services to both consumers and businesses. But as for-profit organizations, banks are in the business of making money.
So, how do banks make money? Ultimately, it depends on the types of products and services they offer. But in general, it’s through various fees and interest charges.
If you’re wondering how your bank makes money off you and how to minimize your costs, here’s what you need to know.
Banks make money in a variety of ways — depending on your relationship with your bank, it’s important to know how you’re contributing to your financial institution’s bottom line.
Banks may charge a variety of fees on the bank accounts they offer. Whether you have a checking account, savings account, money market account, or certificate of deposit (CD), here’s what to look for:
-
Monthly maintenance fee: Some accounts come with a monthly service charge just for maintaining the account. In many cases, however, you can get this fee waived with certain account activity, such as a minimum balance or monthly direct deposit amount.
-
Overdraft charges: Many banks allow you to opt in for overdraft coverage, which allows you to overdraw your account in certain situations. However, they typically charge a fee for each overdraft. If you don’t have overdraft coverage and your bank declines a transaction due to a lack of funds, you may be charged a nonsufficient funds fee.
-
Other account fees: Depending on how you use your account, you may also be subject to other fees. Examples include charges for check orders, out-of-network ATM transactions, check stop payments, paper statements, wire transfers, early withdrawals (CDs only), international debit card transactions, and account inactivity.
To minimize your banking fees, consider opting for a bank that doesn’t charge a monthly maintenance fee. Also, try to maintain a buffer in your checking account to avoid overdrafts, be mindful of which ATMs you use, and avoid other costly features.
A bank’s primary business involves pooling customer deposits and lending that money out in the form of mortgage loans, auto loans, credit cards, and other financing options. Lending-related income is typically broken down into interest and fees:
-
Interest: When you take out a loan or open a credit card, interest is one of the costs of borrowing. Lenders usually offer a range of interest rates on their lending products to account for the different risk profiles among their borrowers.
-
Origination fees: If you’re applying for a home loan or personal loan, you may be subject to an origination fee, which helps cover the costs the lender incurs processing your application. In some cases, you may also be subject to an application fee or administrative fee.
-
Prepayment penalties: With certain loans, lenders may charge a prepayment penalty if you pay off or refinance your loan shortly after you take out the loan.
-
Annual fees: If you have a credit card or line of credit, your lender may charge an annual fee just for the privilege of using the account.
-
Other fees: Depending on the lender and type of loan, you may also face other fees, including charges for late or returned payments, credit report reviews, credit line draws, credit card cash advances, and balance transfers.
You can minimize your loan-related costs by improving your credit score to qualify for lower interest rates and shopping around to ensure you’re getting the best deal possible on a loan or credit card.
If you have a credit card, paying off the balance in full each month is the best way to avoid interest charges.
Some banks also offer investment advisory or wealth management services to their customers in exchange for various fees. Examples include:
You may not be able to avoid all investment-related fees, but shopping around can help you avoid costlier investment services.
Larger banks may also offer other services that may benefit individuals and small businesses. Some examples include:
For each of these services, banks typically charge various fees. If you’re looking for one of these services, take your time to compare banks to ensure you’re getting the best value for what you need.
While banks use customer deposits to originate loans, they generally keep some of those deposits in reserve to comply with federal regulations and meet the needs of their deposit customers.
However, they essentially create money — at least, on paper — when they lend those deposits to new customers. For example, if you have $10,000 in a checking account and $9,000 of that is used to fund a personal loan for another customer, you still have $10,000 in your account, but now the loan customer has $9,000 in their bank account.
With that in mind, it’s important to note that a bank’s ability to create money is dependent on its reserves. It can’t just generate money out of thin air.
All financial institutions charge fees and interest for the products and services they provide. But the value you get in return for the cost of managing your money can vary greatly.
For example, while big national banks offer a wide range of products and services, they’re more likely to charge monthly fees on even basic bank accounts. They’re also less likely to offer high interest rates on deposit accounts.
If you’re unhappy with the service or features you’re getting from your bank, here are some options to consider.
To ensure you’re getting the most value from your bank accounts, consider shopping around for the features that are most important to you. This may include things like higher yields on savings accounts, no monthly fees, ATM fee reimbursements, debit card rewards, and more.
In general, online banks tend to offer better bank accounts because they don’t have the same overhead costs as a brick-and-mortar bank. However, you may also consider community banks, which are smaller and more dedicated to serving a local community.
You’re not going to avoid fees and interest completely by switching to a credit union. However, credit unions are not-for-profit organizations that return profits to their members in the form of lower loan interest rates, higher rates on deposit accounts, and reduced fees.
Credit unions are also more likely to offer better customer service, though they may not provide as many products and service options. They also typically have eligibility requirements you need to meet before you can join.
If you have a high-interest loan or credit card, you may consider refinancing or consolidating the debt with another bank or lending institution that offers better terms or benefits.
Just keep in mind that a high rate may also be a result of a low credit score. It’s also important to evaluate your credit profile and financial situation to determine whether you qualify for better loan and credit card options.
Banks make money in a lot of different ways, but it’s possible to minimize how much of that profit comes out of your pocket. While some service-related fees may be unavoidable, it’s important to shop around for all of your financial needs to ensure you’re getting the most bang for your buck.
While it may be tempting to stick with one bank to keep all of your finances under one proverbial roof, you may be able to get more value by using multiple financial institutions to manage your money and work toward your goals.