WHAT HAPPENS TO MONEY AFTER YOU DEPOSIT IT?
What happens to a $10 bill after you deposit it in your savings account? Does the bank teller take it to a vault and put it into a separate compartment or cubbyhole marked with your name and account number? No.
The bank begins by adding $10 to the amount that is already in your account (your existing balance). Your $10 deposit and your new balance are then recorded in your bank book and in the bank’s computer system. The $10 bill you deposited is mixed in with all the other cash your bank receives that day.
When you and other customers deposit money in a bank, the bank “puts most of it to work.” Part of the money is set aside and held in reserve, but much of the rest is loaned to people who need to borrow money in order to buy a house or a car, expand a business, buy farm equipment, or do any of the other things that require people to borrow money.
Of course, banks do not lend money just to provide a service. They do it to make money. Here’s how it works.
When you keep your savings in a bank, the bank pays you extra money, which is called interest. The interest is added to your account on a regular basis, usually once a month.
Let’s say a bank pays its depositors interest of 3 percent a year on their savings. In simple terms, that means if you keep $100 in your savings account, the bank will add $3 to your account balance during the course of a year.
But, there is another side to interest. When someone borrows money from a bank, the bank charges interest, and it charges borrowers a higher rate than it pays savers. For example, it might pay savers 3 percent and charge borrowers 8 percent. The difference, 8 percent minus 3 percent, goes to the bank. Charging interest on loans is one of the main ways for a bank to make money.
The rate of interest a bank charges depends largely on two things:
• how many people want to borrow money, and
• how much money banks have available to lend.
If a bank has plenty of money to lend, and the demand to borrow money is not particularly strong, interest rates will tend to be low in order to attract borrowers. But when banks have a smaller amount of money to lend, and the demand to borrow is fairly strong, interest rates will rise. As a depositor, you want interest rates to be high, but as a borrower, you want them to be low.
When it comes to paying interest on savings deposits, there usually isn’t a big difference between banks. They pay just enough to stay competitive with one another and attract depositors. So, if one bank is offering a much better (higher) rate than most other banks, try to find out why. And remember the old saying: If something sounds too good to be true, it probably is.
WHAT HAPPENS WHEN YOU APPLY FOR A LOAN?
Last week your mechanic advised you not to spend any more money on the faithful old car that has carried you over many miles of highway. The time has come to shop around for a new one. But cars were a lot cheaper when you last bought one. This time you’ll have to take out a big loan.
You don’t necessarily have to borrow from the bank where you have an account. You should shop around for a lender that offers the best deal, including the lowest interest rate. Sometimes car companies offer low-interest, or even no-interest loans. And don’t forget the internet. You can research a wealth of online resources from the comfort of your home or office.
Your first step is to figure out how much you can afford to borrow. You will not know if you can afford the new car— or if a lender will let you borrow the amount want — until after you complete a loan application. In addition to routine personal information such as your name, address, telephone number, and Social Security number, a loan application also asks for infor-mation on how much money you earn, how long you have worked at your current job, and how much money you already owe on credit card bills and other debts.
The next step is for the lender to evaluate your application and decide if you are a “good risk.” Before they lend you money, lenders want to be as certain as possible that you will be able to pay them back. Do you earn enough money to keep up with your loan payments? Do you have a history of paying your debts on time? To answer these questions, lenders rely heavily on credit bureaus and credit reports. There are approximately 1200 local and regional credit bureaus in the United States. All are private companies (not government agencies), and most are linked by computer to three nationwide credit bureaus. They provide much of the informa-tion that lenders need to evaluate loan applications.
When you apply for a loan, your bank contacts a credit bureau and asks for a copy of your credit report, which is basically a summary of your payment habits — information about loans, charge accounts, credit card accounts, bankruptcies, and court judgments that might require a potential borrower to pay a large sum of money as a settlement. How the information gets into your credit report is no mystery. When you apply for a new charge account or credit card, clerks transfer information from your application to electronic records that are forward-ed to one or more of the nationwide credit bureaus. If you are late in paying your bills, or if you miss a payment, the information goes into your credit report. Lenders then evaluate your report and try to decide if you are a “good risk.”
After weighing all the information, your bank will either approve or deny your loan request. If your request is denied, the bank must notify you in writing within 30 days, and the letter must state the reason for denying your loan. If your loan is approved, the bank will give you a check made out to your auto dealer or transfer the funds to your account. To protect itself in case you fail to repay the loan, your bank will hold the legal title (ownership papers) to your purchase until you pay off the loan.
Before applying for a loan, you should request a copy of your credit report. If there are any issues or questions, you may be able to address them before processing a loan application. You are entitled to a free copy of your credit report, at your request, once every 12 months. For more information on how to request a copy, visit the Federal Trade Commission website at http://www.ftc.gov
