Have you ever wondered how loan companies are able to make loan profit? If you have loaned or borrowed money from a lender or a bank, you may have pondered upon the question. You may imagine that they have a pile of cash somewhere which decreases every time someone borrows money and that they can only give out so many loans before the pile of cash totally runs out. How can your lender or bank not only give you a loan but also make money?
Loan Profit from Net Interest Margin
It turns out that loan companies do not actually have that much cash in physical form that they have a pile of it stashed somewhere. Although this is true, they do still need an inflow of money before they can start to offer loans. The ones that provide the money are depositors or investors.
Therefore, from this, you can see that investors lend money to the loan companies. They will be paid back with interest, so that is how they profit from it. On the other hand, bank depositors will get interest rates that are significantly lower than investors. This is because they have the right to withdraw all of the money in their balance anytime that they want to, while investors basically give up the right to access their money for a certain amount of time.
You may have noticed that banking customers or interest investors are paid lower than the interest rate that banks or loan companies charge those who borrows money from them. The difference between the two is called as the net interest margin and that is how lenders make a profit.
Loan Profit from Fees
However, loan companies and banks do not solely make money off of the net interest margin. Another source of profit for them are fees, and this is something that consumers should be careful of. One of these fees is the application fees that a borrower has to pay for when they apply for a loan. Sometimes borrowers can pay for this from the money that they already have, or it will be included in their loan which means that they have to pay interest for it as well. ATM fees and account fees are also two types of fees from which loan companies profit from. There are also fees in the form of penalty charges. You have to pay penalty charges if you are late to make your payment on a loan or you do things such as overdraw your account.
Even though some aspects of what is done by banks can seem difficult to understand or even magical, it remains an important thing for both investors and borrowers as consumers to understand the simple methods of how banks and loan companies make their profit. The reason for this is because when you have this knowledge on loan profit, you will be able to acknowledge and stay away from fees that are unnecessary for you to pay and therefore minimize your interest payments as much as you can.