If you have any amount of money, you probably have a bank account to go with it. Banking doesn’t have to be complicated, and all of this bank stuff doesn’t have to be a mystery!
Let’s unpack exactly how banks work, how they make money, and how you can use banks to your advantage.
How Do Banks Work?
Banks are strange institutions. A lot of how they operate depends on debt. Most banks have $20 in debt for every $1 in equity. That’s basically saying that banks are borrowing a lot more money than they’re worth.
Banks are businesses, just like a grocery store or a restaurant. They offer a variety of products, including loans, accounts, and cards.
Banks operate on a highly leveraged business model. It’s not as complicated as it seems, either.
Basically, you open an account at the bank. After you put money in the account, the bank will use your money for one of two things: they’ll loan it to someone else, or when someone else comes to withdraw their money, they’ll give it to them.
You’re probably thinking, “What? The bank is giving my money away?!” If you’re afraid of that, don’t worry! You can go back to the bank at any time and take your money back out. The bank will just take money from someone else’s account to cover what you withdraw.
Because the banks borrow your money to loan it to other people, they pay you interest on your balance.
How Do Banks Make Money?
Like I said before, banks are businesses, and they have a lot more debt than they do actual money. They have to somehow turn a profit in order to stay in business, pay the employees, and build more banks, right?
Banks make their money three different ways.
Interest on Loans
When the bank lends money to someone, whether that’s through a mortgage, a credit card, or car loan, they charge them interest. Interest can add up over time, especially on large balances.
Whenever you swipe your credit or debit card at a store, the bank charges the store a fee for taking your card. This fee is small, between 1.1%-1.7%. However, with millions of people making purchases and swiping cards every day, that adds up to quite a lot of interchange fees!
Banks charge all kinds of fees on accounts, which include loans. Banks charge overdraft fees, late payment fees, ATM fees… where does the fee madness stop? Along with interchange fees, banking fees make up 50% of a bank’s total revenue.
With all of these people taking out crazy loans, and banks always moving money around, what happens if the bank goes broke? What happens to your money? Will you ever get it back?
There’s good news! Many banks carry FDIC Insurance, which is insurance on the balance of the accounts that the banks hold. FDIC Insurance was first introduced in 1933 after the Great Depression, where lots of people lost their life savings because the banks just didn’t have the money.
FDIC Insurance covers each depositor up to $250,000 per bank, per ownership type. What in the heck does that mean?
This means that if you have more than $250,000 in any one bank, you only get back $250,000 if the bank closes. Any money you had over that $250,000 is lost, because it is not FDIC insured.
If you start to accrue more money than that, you might want to consider using multiple banks. You could also invest that money, which would make you even more money.
Banks are a pretty safe place to keep your money. There are two primary types of accounts you can open with a bank: a checking account and a savings account.
A checking account is the account you use to spend your money. Checking accounts don’t have a limit on how many times you can withdraw money from your account, and you can withdraw that money a few different ways. You can use a debit card, a check, or an ATM (which requires your debit card).
Before we talk about all the great things you can do with your checking account, I’d like to pass along a word of warning. Your checking account balance is not unlimited. You should only spend what you have, or you could be paying a lot more for it later.
When you spend more money than you have in your checking account, that’s called an overdraft. If your account has overdraft protection, then the bank will cover the difference, but they’ll charge you an overdraft fee. The average household pays $200 a year in overdraft fees.
If you don’t have overdraft protection on your account, your debit card will decline or your check will bounce. Most stores and banks will charge a fee for a bounced check, and, if you receive a bounced check, your bank could charge you a fee to return the check to the writer.
Withdrawing Funds From Your Checking Account
At some point, you’re going to want to withdraw money from your checking account. You can do this one of two ways: you could use a debit card, or you could use a check.
Debit cards function exactly like credit cards, if you’re familiar with those. The only difference between debit cards and credit cards is that the debit card only has the money that is in your checking account.
To use your debit card at a store, all you need to do is swipe it or insert the chip into the card reader, and then enter your PIN number. The money will be taken out of your account. Congratulations! You just made a debit card purchase!
To use it online, you’ll have to use the credit card option if there’s not one for debit cards. You’ll enter your card number, the date that it expires, and the card security number. The card number is that long line of numbers on the front. The date that it expires will be in the date form MM/YY. The card security number is on the back, next to the spot for your signature.
Just remember: you can only spend what you have if you’re using a debit card (unless overdraft fees sound delightful to you).
If you’re old-school like that, or you need a check for some odd reason, knowing how to write a check is a crucial skill.
Writing checks isn’t actually as hard as it looks. First, you need to write who the check is for under the “Pay to the Order of:” field. Make sure you put the correct name or business on the check, or their bank won’t take it!
There’s a box with a dollar sign next to it on the right side of the check. Using numbers, write how much the check is for.
Next, you’ll fill out the field below the “Pay to the Order of:” field. In this blank, you’re going to write out, in words, exactly how much the check is worth. If your check has cents attached to it, you’ll write out that portion as a fraction out of 100.
There’s a memo field on the check, but you can leave that blank if you want. Most people use that to confirm what the check is for. Next, you should sign the check.
Now, you can give the check to the person it’s for, and you’re good to go!
Sometimes, you’re going to be given a check. Maybe it’s your paycheck, or a rent check, or your aunt sends you a birthday check. Whatever the occasion, you need to know how to deposit a check!
First, you need to decide how you want to deposit the check. You could do it in person at the bank, or you could deposit it using your bank’s app. My favorite way to deposit a check is over mobile, because it’s quick, easy, and I don’t have to make a trip to the bank.
We’re going to cover mobile deposits today, because a bank teller can help you deposit in person.
When you get your check, make sure all of the appropriate fields are filled out. The bank won’t take it if one of the required fields is blank! Next, flip the check over. There’s a line that says, “Endorse Here.” Sign on that line, but not too big! You’ll need room to tell the bank where to put the check!
On the next line, you’re going to write, “For deposit only to account [your account number].” Some banks want this all on one line, and some give multiple lines. It’s a good practice to write this part on one line, so write small!
Below is an example of a properly endorsed check:
Next, open your app and go to the Deposit screen. Your app should walk you through exactly how it wants you to take pictures of both sides of the check. Make sure you enter the proper amount of the check into your app when it prompts you.
Congrats! You’ve deposited a check! Now that you’ve deposited the check, write VOID across the front of the check in pen, then tear it up or shred it. This way, no one can try to deposit your check and cause a huge mess.
A savings account is a great place to keep money you don’t want to spend right away. You can use it for sinking funds, your emergency fund, or other reasons to save money.
A savings account is almost like a checking account, but you have a limit on how many withdrawals you can make, and it makes a much better (but still pretty bad) interest rate.
The interest rate on your savings account is the fee the bank pays you for the privilege of using your money to lend it to other people.
The average interest rate on a savings account is a meager 0.18%. If you have an emergency fund, and you want to invest money on top of it, you should look into other options for your money.
Auto-draft To Savings
Some of us have a hard time paying ourselves first. Luckily, most banks offer an auto-draft feature for your checking account. Basically, what this does is it takes a certain amount of money out of your checking account and puts it into your savings account.
This is super cool, because it can put us in the habit of paying ourselves first with minimal effort. That money just leaves your account without you having to jump through hoops. Isn’t that awesome?
Banking Isn’t Hard
Banks don’t have to be this mysterious corporation that does strange things with your money. Now you know how they work and how to use them to your advantage. Are you enjoying your journey to learn about money? What’s your favorite lesson? Let me know in the comments!