Many things led us to this point, but what stuck out to me was that the majority of reasons boiled down to two things: safety of your money and ease-of-use. These days, most of us feel pretty safe with our money in the bank. After all, it\u2019s usually insured by the FDIC (thanks to the Great Depression), and as for \u201cease of use,\u201d I think that\u2019s debatable. Sure, by today\u2019s standards, access seems quicker with new technology, but in places like the U.K., money tends to clear much faster than it does here in the U.S.<\/p>\n
Either way, the bank definitely acts like we can come get our money whenever we want; just, of course, bear in mind that\u2019s subject to hours of operation, how many business days are permitted for your transaction, etc. This apparent ease and safety is what really attracts money to them, after all. And it\u2019s with this money that they make money, right? Yes and no. Here\u2019s what I mean.<\/p>\n
It can be quite difficult to understand how banks really make their money because banks operate very differently from most businesses since most are highly leveraged, with more than $20 in debt for every $1 of equity. Not to mention, banks don\u2019t make any tangible products and they often offer things like checking accounts for free. On top of that, most people have the process of how the bank lends and borrows backwards. A good analogy would be how the government works, which people also confuse how they spend and borrow. People imagine that the government must first collect taxes or borrow money in order to fund budgetary needs and expenses. In reality, the government just spends what it wants and is approved for and then collects taxes in order to balance out the effect the spending has had on the money supply. Isn\u2019t it funny how people think the opposite about both the government and the bank? The important thing to remember is the government spends first and funds later, and banks lend first and fund later.<\/p>\n The way the process works in a nutshell is this: Banks attract depositors by offering to pay interest on funds held in deposit. They then pool their depositors\u2019 funds and lend this capital to qualified borrowers at a higher interest rate. Simple enough. The bank earns money on the spread between the rate of interest it pays out and the rate of interest it charges on loans. This is called the \u201cnet interest margin<\/a>.\u201d Bank regulations require banks to maintain a set level of capital to satisfy those who have their deposits in accounts, so that money can be readily accessed but occasionally a bank may run low on cash and need to borrow short-term funds from the Federal Reserve.<\/p>\n These loans are made at a low interest rate, commonly referred to as the Federal Reserve discount rate. What\u2019s unique about this strategy, called \u201cfractional reserve lending<\/a>,\u201d is that the bank has lending power on capital they don\u2019t necessarily have in-house. And they borrow it at this low Federal Reserve rate and make a spread. This is also done to expand the economy by freeing up capital that can be loaned out to other parties. This system was also partially implemented because of incidents during the Great Depression where many U.S. banks were forced to shut down because too many people attempted to withdraw assets at the same time.<\/p>\n So, that\u2019s one way banks make money\u2014leveraging both the Federal Reserve\u2019s money as well as borrowers\u2019 and depositors\u2019\u2014but that\u2019s not everything. Everyone thinks the bank is in the lending and saving business with borrowers and depositors, but they\u2019re also in the spending <\/em>business. Americans spend more than they save; this much we all know. And guess what? The bank knows this too! This is why they got into the credit and debit card business, especially once they implemented revolving balances.<\/p>\n So, every time you swipe a card at a store, the merchant pays a small percentage of the money to the bank that issued the card, called an interchange fee. For credit cards, this is around 1.7%, while for debit cards it is closer to 1.1%. Just imagine how many cards are being swiped at this very moment. Clearly, this is a huge revenue stream for banks.<\/p>\n Prior to this class, I pretty much thought that the \u201cnet interest margin\u201d idea of depositors putting money into the bank, which they in turn would lend out and charge interest, was how they made their money. It wasn\u2019t until I had a better understanding of the Federal Reserve and the centralized banking system that I realized that\u2019s not the only way. Take mortgages, for example. Most banks aren\u2019t known to originate or create a residential mortgage and necessarily keep it in its portfolio. Although there are portfolio lenders out there (which is more common with commercial loans), the majority of residential mortgages are packaged and sold off where the originating bank is following the proper guidelines to enable them to do so, in order for them to make their points (1% of the mortgage amount) and any other origination fees, etc. It\u2019s really more about the fees than the interest. The interest is more of a thing for the larger institutional investors like insurance companies and pension funds.<\/p>\n And it\u2019s not just with mortgages either. Banks discovered that to call a product \u201cfree\u201d was a great form of marketing (think \u201cfree checking\u201d), but then charging small fees on mostly all transactions\u2014ATM fees, overdraft fees, late payment fees, penalty fees, etc. In the U.S. today, the average household ends up paying over $200 annually in just overdraft and bounced check fees alone. A recent statistic by the CFPB states<\/a> that in 2016 alone, U.S. consumers paid a total of $15 billion in fees for bouncing checks or over-drafting. Along with interchange, these fees add up to more than 50% of revenue for large banks. So not sure how to put this other than\u2014THEY\u2019RE CHARGING YOU FEES TO USE YOUR OWN MONEY!<\/p>\n So, the real question is, how can we be more like the bank?<\/em>\u00a0Well, we could start by acting like one. Keep your money moving in different investment vehicles (aside from reserves; don\u2019t just let it sit there), use leverage to acquire assets, and charge fees and points when lending. And as you\u2019ll read in my new book<\/a>, the ways of being the bank don\u2019t stop there. The possibilities are really limitless, especially when you start synergistically using notes and hard real estate.<\/p>\n So, as real estate investors, we shouldn\u2019t try to \u201cbeat\u201d the bank. Not only is it futile, but they\u2019re not even the enemy. In fact, many times, it\u2019s the bank that enables us to make money. They give us the money to acquire our deals, do new construction, or even provide the permanent financing to take out our hard money or private money lenders. Without the banks\u2019 money, it would have been very difficult to grow my portfolio to its current size, enabling me to provide more rentals to the greater public, and eventually own more real estate long-term. And let\u2019s not forget: Whether directly or indirectly, they also provide us with notes! So I say, when you can\u2019t beat them, join them!<\/p>\n![\"\"](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2018\/02\/conventional-loan.jpg\" "\\"\\"")
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\nRelated:<\/strong> Which is the Riskier Investment: Performing or Non-Performing Notes?<\/a><\/em><\/p>\nNet Interest Margin (a.k.a. Using Leverage)<\/h2>\n
Interchange (a.k.a. Points)<\/h2>\n
Fees (a.k.a. Fees!)<\/h2>\n
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\nRelated:<\/strong> The Beginner\u2019s Guide to Building Wealth With Private Notes<\/a><\/em><\/p>\n![\"Buying](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2017\/12\/duplex.jpg\" "\\"\\"")
<\/p>\nBe Like the Bank<\/h2>\n
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