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Hi, not educated in economics, but it seems like the banks mostly given out loans that are well below current rates and inflation. So that the money coming back in from home loans is tiny and worth less after inflation.
Isn't this bad financially for banks?
I asked someone this question who said it was no big deal, but I didn't comprehend their answer. Can anyone explain it to me like I'm 12 instead of 22! Thanks!
You're right to be skeptical! Giving out loans below inflation might seem weird for banks, but there's more to it than meets the eye! Let's break it down, using ice cream as a metaphor:
Imagine the bank is an ice cream shop. They have a limited amount of ice cream (money) and want to sell it (lend it out). But if they don't, their ice cream melts (money loses value)! So, they offer "future scoops" (loans) hoping to get more ice cream back later.
Now, imagine two scenarios:
1. Hot day: Inflation is high, like a scorching sun. The ice cream melts quickly! So, the shop offers "future scoops" slightly overpriced (higher interest rates) to cover the melting and make a profit.
2. Cold day: Inflation is low, like a cool breeze. The ice cream melts slowly! The shop can afford to offer "future scoops" at a discount (lower interest rates) because their ice cream isn't losing value as fast.
Now, back to banks:
Home loans are often fixed-rate, meaning the interest rate doesn't change for the loan term. If they set the rate too high at the beginning, nobody might buy their "future scoops" (take out loans).
Banks also consider risk: people with good credit scores are "safe scoops" (less likely to default), so they get lower interest rates. Those with shaky credit are "risky scoops" and pay higher rates.
Even with low interest rates:
Banks make money off the total loan amount, not just the interest. A large loan with a low interest rate still brings in more money than a small loan with a high interest rate.
They diversify: they don't put all their ice cream in one cone! They also invest in other things, like stocks and bonds, to stay profitable even if some "future scoops" melt a bit.
So, is it bad? Not necessarily! It's a balancing act. Banks need to offer competitive rates to attract borrowers, manage risk, and stay profitable.
You're right to be skeptical! Giving out loans below inflation might seem weird for banks, but there's more to it than meets the eye! Let's break it down, using ice cream as a metaphor:
Imagine the bank is an ice cream shop. They have a limited amount of ice cream (money) and want to sell it (lend it out). But if they don't, their ice cream melts (money loses value)! So, they offer "future scoops" (loans) hoping to get more ice cream back later.
Now, imagine two scenarios:
1. Hot day: Inflation is high, like a scorching sun. The ice cream melts quickly! So, the shop offers "future scoops" slightly overpriced (higher interest rates) to cover the melting and make a profit.
2. Cold day: Inflation is low, like a cool breeze. The ice cream melts slowly! The shop can afford to offer "future scoops" at a discount (lower interest rates) because their ice cream isn't losing value as fast.
Now, back to banks:
Home loans are often fixed-rate, meaning the interest rate doesn't change for the loan term. If they set the rate too high at the beginning, nobody might buy their "future scoops" (take out loans).
Banks also consider risk: people with good credit scores are "safe scoops" (less likely to default), so they get lower interest rates. Those with shaky credit are "risky scoops" and pay higher rates.
Even with low interest rates:
Banks make money off the total loan amount, not just the interest. A large loan with a low interest rate still brings in more money than a small loan with a high interest rate.
They diversify: they don't put all their ice cream in one cone! They also invest in other things, like stocks and bonds, to stay profitable even if some "future scoops" melt a bit.
So, is it bad? Not necessarily! It's a balancing act. Banks need to offer competitive rates to attract borrowers, manage risk, and stay profitable.
Your home also becomes a asset on the banks books. They aren't losing anything.
Location: We_tside PNW (Columbia Gorge) / CO / SA TX / Thailand
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Banks, like Costco, generate operating cash flows from fees. Their business customers pay lots of fees.
Businesses, and especially farms and factories must annually renew their lines of credit. Commercial real estate mortgages are renewed every 5 years, with higher interest + the usual fees.
'At risk' borrowers pay dearly, daily. (New revenue)
Plus the banks have significant investments, and a staff of finance experts putting your deposits to work, very effectively. Such as lending the government the money it needs next week to meet payroll. Banking is a big business, with decent returns. (They hold the dough)
90% of loans that are originated by banks are sold to Fannie/Freddie within 30 days. They don't keep them.
I've always used local saving and loan banks who held onto my mortgages.
However, the truth is many mortgages are sold to servicing companies
Quote:
By selling loans, lenders can quickly free up funds to lend to other potential buyers. Lenders often bundle loans together (usually those with similar risk attributes) and sell them to investors. These investing companies (typically government agencies like Fannie Mae and Freddie Mac) then sell them as bonds. In the big picture, this practice helps keeps rates competitive and boosts the economy.
Every time you make a mortgage payment the bank turns around and loans it back out. As mentioned, they will often bundle the loan contracts up and sell them, so the buyer gets some good stuff at little risk and they get some crap at higher risk. Either way the bank is rid of it because someone else gave them some money for it, which they then loan back out.....
Every time you make a mortgage payment the bank turns around and loans it back out. As mentioned, they will often bundle the loan contracts up and sell them, so the buyer gets some good stuff at little risk and they get some crap at higher risk. Either way the bank is rid of it because someone else gave them some money for it, which they then loan back out.....
Have you ever heard of the shell game?
Not all banks and not all loans. The mortgages made by high credit score people are kept by banks. Some banks like local savings and loans holds mortgages.
But you're right for the majority of mortgages - it's a shell game. The government requires banks to right a certain number of mortgages to consumers who are poor risks, so why should banks keep the loans likely to fail?
Of the five or six mortgages I have had....ONE for a second home was held by the bank, until I paid it off.
That's rare. My mortgage is serviced by my Credit Union who originated it, but they still sold the loan itself within two months so it's off their books. At least I probably don't have to worry about them handing it off to another servicer in the future as that's not their policy. Nice to be able to walk in at any point and make a payment at a teller window if I have to.
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