How do banks make money?

Think about this. If all the profits that they make are only coming from borrowers making their 30 years mortgage payments on time, don’t you think they will eventually run out of money to lend? You bet. Here are few ways how banks make money off you.

  • Interest payments: This is the simple one (if not, the only one) that everyone knows. You keep making your mortgage payments; banks keep earning interest over the life time of your home loans

 

  • Refinancing: Since a big portion of your mortgage payments within the first 10-15 years are going towards interest rather than paying down the actual loan amount that you originally borrow, banks LOVE asking you to refinance. Unless you are refinancing by lowering  existing loan terms (or similar to the remaining loan terms) with lower interest rate, refinancing from a 30 year loan that you have been paying for the last 10 years into another 30 year mortgage isn’t really saving you much over the lifetime of the loan. Banks get to keep all the payments you have been and milk you an additional 30 years. I am not discouraging you from refinancing (if I do, I will be out of a job right?), but make sure the new loan term makes sense and actually save you money in a long run. Not just a few bucks a month.  

 

  • Selling it to investors: Have you ever received that annoying letter in the mail asking you to start making mortgage payments to a different bank? Well, that’s because your home loan is being sold to an investors in the secondary market. When your home loan closes, banks turn around and find investors to purchase your loans. They don’t want to keep it. They want to sell it off now and make a profit NOW.  Not only can they get back the amount that they lend to you, they also get an additional profit from investors (I will explain how it works in a different article soon). When that is all done, they turn around and lend money to someone else. Investors are the reason why we have different guidelines and requirements on home loans. We want to package your loan nice and neat to sell it. The last thing the banks want is to keep your loan for 30 years, crossing their fingers that you will not default. This is actually the reason why many banks have collapsed over the past few years. They had loosened up loan guideline requirements for short term profits, and many of these bad loans became unsalable in the secondary market. To top it all off, borrowers start defaulting and stop making mortgage payments all together. Imagine that.

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