As I said in the previous post, banks make their money off the spread between what they make on interest income through loans and mortgages and what they pay on deposit interest. They try to match the maturities of these two services to control their working capital and cash flows. What they do is they take the money people deposit in savings accounts and GICs and lend it out to people looking to borrow money. This is why when you try to pay off a loan early or get out of a term deposit before its maturity, you may have to pay a penalty. The bank is currently using that capital to generate income, and by pulling out of a contract you are forcing them to change these cash flows. You are not to worry about
liquidity** though, as all deposits in major banks are insured by the government up to a certain amount (usually up to $100 000 depending on what country you live in).They offer a variety of accounts to their clients; here is a list.
Checking Accounts:
This is the most common account banks offer as most people with bank accounts offer them. Checking accounts generally offer little or no interest and are used for every day transactions. Most people have a debit card, use online banking, and write cheques through these accounts.You should look for a bank that offers free transaction services. Some banks may require you to maintain a minimum balance to obtain these services, however if you search you should be able to find a checking account that does not charge you at all per transaction.
Savings Accounts:
These accounts are also very popular. Their main purpose is to encourage members to save their money. They are fully liquid accounts, meaning that funds deposited into these accounts can be withdrawn without penalty at any time. Many have transaction fees to discourage constant use of the account, and encourage saving. When looking to open such an account, people should always look for a "
high interest savings account". High interest savings account have all the same features of savings accounts however they pay higher interest. Generally you should look to receive between 1-2% on deposits in these accounts.
Tax-Free Savings Accounts
These accounts generally carry the same interest rate of high interest savings accounts, however they are registered with the government. All deposits into these accounts are tax free meaning they can be written off on your income tax. You may be thinking, "So why don't I just put all my money into this account and not pay income tax at all?" Well it does not work like that, otherwise the government would make no money and we would be driving on dirt roads. There is a contribution limit to these accounts per person. It is usually around $5000 but it depends again on where you live. Everyone should take advantage of these accounts, which allow them to keep more of their hard earned money!
Guaranteed Investment Certificates (GICs)
GICs are short-to-medium term investments that most banks offer to clients. They have terms of 30 days to 5 years. The interest rate they pay out increases with maturity. For example, a 1 year GIC may pay 1.5% interest whereas a 5 year GIC may pay 4% interest. You should always ask you bank if they use a
compound interest method or a simple interest method. You always want compound interest because this means you are earning interest each year on the interest you earned from the previous year. With simple interest, you only earn interest on your principle each year, so you will make slightly less than you would with compound interest. GICs are very safe investments and there should be no worry of the banks ability to pay you upon maturity.
Personal Loans
Personal loans are sums of money lent out to clients for a specific period of time, usually 1-5 years. They carry interest rates mainly between 5-20%, depending on your credit score, the amount you are borrowing, and if you have collateral for the loan. Collateral are personal assets that you have that can be written against the loan meaning that if you fail to pay it off with interest, they can cease these assets. Banks will always check a persons credit score before lending to them. You should aim to have a high credit score, usually over 700 if you want to be accepted without issues. Loans are typically between $1000-$100 000. You should aim to have short term loans with low interest rates so that you can pay them off as quickly as possible. Don't buy things that you cant afford!!
Line of Credit
A line of credit is a type of loan where you only use what you need. They can be anywhere between $100-$250 000. When you need to use a portion of it, you transfer the money into your checking account. Each month you are required to pay a portion of the interest, and at years end you must repay a certain percentage of the principal.
Variable vs. Fixed Rate Loans
The difference here is simple. Fixed rate loans offer a set interest rate that will not change throughout the life of the loan. Variable rate loans have an interest rate that fluctuates with market conditions and the economy. For this reason, they are less risky to banks and thus offer lower interest rates. The risk to the borrower is that the rate could rise above previously issues fixed rates if the economy takes a turn for the worse.
I will discuss mortgages in their own blog. Once again, thank you for taking the time to ready my blog. I hope it can help you in your dealings with banks in the future!
