Reposted from www.learnvest.com
Sometimes it seems like you need a Ph.D. to understand
what banks are talking about. Checking accounts we get, sure. But money market
accounts? CDs? Variable interest rates? We just want somewhere to keep our
money!
For that reason, most of us, when we set up our banking,
just walk into a big-name bank, grab the first person we see with a name tag
and say,
"I need to open a checking account."
No wonder less than half of women in the U.S. report
feeling satisfied with their financial stability, according to the American
Psychological Association. How can you possibly feel good about your finances
without knowing the fundamentals of banking?
Checking accounts are one of the most popular deposit
accounts opened at financial institutions, so you probably already have your
hard-earned funds sitting in an account waiting for your next expense.
But even if you’ve already opened a checking account,
it’s never too late to understand how your bank handles your funds and helps
you manage your money. The sooner you get a handle on it, the sooner you can
reap all its benefits.
Banking in a Nutshell
Banking is a general word that describes all the services
offered by a bank, credit union or other financial institution. Primarily,
these institutions deal with two types of products: deposit accounts and loans.
Examples of deposit accounts include: checking accounts
and savings accounts which are the most commonly used, certificates of deposits
(also known as CDs), money market accounts and individual retirement accounts
(IRAs). With deposit accounts, customers like you entrust the bank or financial
institution with the safekeeping of your money for a short-term or long-term
period.
Another popular banking service is loans, which is how
banks make money for a profit. Banks loan money to you, if you qualify, for
big-ticket items such as a mortgage loan for your dream home, a student loan to
help send your daughter to her top-pick university, or a personal loan to pay
for an unexpected medical bill. Bank loans allow you to pay for major expenses
using money you don’t immediately have.
How Banking Works
What you may not realize, however, is what happens behind
the scenes.
As you deposit money into a deposit account like your
savings, the bank borrows your money and puts it into a pool of funds used to
loan out to other customers. A common misconception is that when cash is
deposited into your personal account, that same cash is left idle in your
deposit account until you withdraw it. In reality, your money is circulating to
feed a massive economic cycle so that you, your friends and your family can
purchase homes, buy cars and borrow when needed.
By this point, you’ve got to be wondering: why on
Earth do banks do this?
Banks, like any other commercial establishment, are a
business. Their main goal is to make money, which they do with interest rates.
When a customer like you is approved for a bank loan, you
pay the bank interest on the amount you borrowed. The bank then gives a small
portion of that interest to depositors as a “thank you” for letting the bank
loan out your original deposit (and to give you incentive to continue
depositing money into the account). The bank keeps the remainder of the
interest from the loan as profit.
Surprised to find out your money doesn’t actually stay
put with the bank? Well, rest assured banks are required by the Federal Reserve
Act to have reserve funds (i.e. money set aside) should you ever want to
withdraw your money. However, if there were to be a crisis and every single
customer wanted to withdraw her money all at once, there is a high chance that
the bank wouldn’t have enough to go around.
Why Banking Is
Important
At first, you may feel a bit betrayed—after all, you
deposited your money trusting that the bank would keep it safe and accessible
to you when you most needed it. Now that you know exactly how banks operate,
you can learn how to benefit from the cycle.
Here are a few reasons why banking is important for your
bottom line:
It earns you money. By
depositing (i.e. lending) your money to a bank, you’re earning interest and
growing your own profits. This means that financially, you’re that much closer
to reaching your goals for a down payment on your first home or saving up for a
new Ipad.
The government will insure money you keep in
the bank. Most financial institutions are insured by a third-party
federal entity like the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union
Association (NCUA) in the event a bank goes south. What does this mean for you?
It means that even if a bank fails, you are guaranteed to get back every single
dime you’ve deposited up to $250,000. You can’t get that kind of guarantee from
your mattress!
Bank products help you budget. Banking
products give you the ability to easily divide up your money to reach different
goals. For example, you can allocate $1,500 to your checking account per
paycheck, $150 to your general savings account per paycheck and $150 to your
retirement savings account per paycheck. This separation of money keeps you
from dipping your hands into savings and allows you to stay on track with a
monthly budget.
With the development of electronic (online) banking, you
can also take control of your money with helpful tools like direct deposit,
automatic bill pay and electronic fund transfers.
What to Keep in Mind
When You Bank
In general, when banking, instead of focusing on your
immediate needs (i.e. walking into a bank and saying, “I need a checking
account”), take a step back and consider these general banking principles:
1. Maximize your
profit.
The point of banking is to keep your money safe and earn
interest on it while paying the least for that service. So when you look for a
bank, search for the highest bank rates (the percentage you earn for depositing
money into your account) to take advantage of “free” money, but also keep in
mind the fee the bank charges to hold your account. Unless the interest rate is
so generous it outweighs what you would pay in fees, it may be more beneficial
to seek out a bank that has zero service fees applied to accounts. Depending on
the type of deposit account you’re opening, some interest rates are “fixed,”
meaning they do not change for a predetermined time frame; some deposit rates
are “variable,” meaning that interest rates can go up or down depending on the
market.
2. Look ahead.
Sure, now you only need a basic checking account,
but what about loan services that you may need to use down the line? When
choosing a bank, it’s helpful to learn and be aware of what products and
services they provide, especially because banks sometimes offer discounted loan
rates for customers who already have deposit accounts with them. However,
LearnVest recommends you always keep your checking and savings accounts at
different banks, so you aren’t tempted to dip into your savings for
non-emergencies.
3. Go for convenience
and ease of use.
Locate a bank that is convenient to work with. If you
need a physical bank, choose one close to home, and whether you go with a
physical bank or an online one, make sure that it has many in-network ATMs
nearby, and a 24-hour customer care center. We also recommend choosing a bank
that offers electronic banking options so can manage your money easily and
aren’t hit by late fees and penalties.
Remember …
Banking has become almost a natural part of how we handle
our money, and for obvious reasons. By acting now and opening a bank account or
re-evaluating the one you currently have, you can become more efficient and
organized—and earn yourself more money in the process.
Term Sheet
Banks
n. A financial institution that holds money in deposit accounts and also lends money to individuals and small businesses.
n. A financial institution that holds money in deposit accounts and also lends money to individuals and small businesses.
Credit Unions
n. A nonprofit financial institution owned and operated by its members. Credit unions often provide similar products as that of a bank.
n. A nonprofit financial institution owned and operated by its members. Credit unions often provide similar products as that of a bank.
Deposit Rates
n. The percentage of interest a financial institution pays to customers for depositing money into a deposit account.
n. The percentage of interest a financial institution pays to customers for depositing money into a deposit account.
Loan Rates
n. The percentage of interest a financial institution charges customers for borrowing money from the bank.
n. The percentage of interest a financial institution charges customers for borrowing money from the bank.
Deposit Accounts
n. What banks offer customers to hold their money for deposits and withdrawals for the short and long term. There are three different types of deposit accounts which include: transactional deposit accounts, savings deposit accounts and time deposit accounts.
n. What banks offer customers to hold their money for deposits and withdrawals for the short and long term. There are three different types of deposit accounts which include: transactional deposit accounts, savings deposit accounts and time deposit accounts.
Loans
n. Funds borrowed by an entity or person, which the borrower pays back to the lender in full, with added interest.
n. Funds borrowed by an entity or person, which the borrower pays back to the lender in full, with added interest.
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