Any borrower who has taken out a loan with a bank or a lender has probably spent some time wondering how on earth loan companies could afford to part with such a large chunk of change.
If you’re like me, you might imagine that your loan officer has to go into an underground vault in order to get the necessary cash for your loan, leaving the pile of money much smaller afterward.
You might surmise that there are only so many loans a particular loan company could give out before that pile of cash in the vault would be completely depleted — so how could your lender not only afford to give loans, but also make money off of them?
Thankfully for our economy, loan companies do not keep piles of cash in underground vaults for borrowers. The reality is that lenders rely on money to make money, but it’s not as simple as a basement full of cash. Here’s a breakdown of how loan companies are able to lend to borrowers and make a profit.
Loan companies start with investors
While your loan company doesn’t have a physical pile of cash, there does need to be an influx of money before lenders can start offering loans. That money comes either from investors or depositors.
For instance, when your weekly paycheck is direct deposited in your bank, that money becomes part of the capital the bank uses to make loans to borrowers.
Investors (or banking customers who are depositing money) are effectively lending money to the bank, for which they will be paid back interest. Bank depositors will receive much lower interest rates than investors because they reserve the right to withdraw their full balance at any time, whereas an investor is generally giving up access to their money for a certain term.
You’ve probably noticed that the interest investors or banking customers are paid is lower than the interest rate that the loan company or bank charges borrowers. That difference, known as the net interest margin, is where lenders make their money.
Banks profit from the difference between what they earn in interest from borrowers and what they owe in interest to investors and depositors.
Considering the fact that banks and loan companies are in the business of making as much money as possible, why don’t all investors and depositors receive minuscule interest rates, and why don’t all borrowers pay ginormous interest rates?
Even though a bank is free to set its own rates, it also has to take several other factors into account.
1. Federal reserve monetary policies
The United States Federal Reserve influences interest rates in a variety of ways, including setting the federal funds rate (the interest rate banks use to borrow and lend with the Fed and each other). The federal funds rate helps to set the “prime rate,” which is the interest rate a bank would charge an ideal, credit-worthy customer.
The market levels for interest rates among various banks and lenders help each loan company determine its rates. If a lender has the poorest rates in town, no one will want to invest or borrow from them.
3. Inflation and market volatility
Banks must look at the cost of inflation and potential market volatility of the life of a loan, particularly for long-term loans. The interest rate charged to a borrower has to take into account how much inflation might eat into the bank’s net interest margin.
In addition, fluctuations in the market can affect how much a dollar is worth and whether customers will be looking to either invest or borrow.
How loan companies inject money into the economy
One of the most fascinating aspects of the lending process is how it’s able to use investors’ money to “create” more money. Here’s how:
Let’s say an investor named Harry comes to the bank and deposits $10,000 in his savings account. The bank keeps $1,000 in reserve. The following day, a student named Sarah takes a $9,000 student loan from the same bank.
By lending out the $9,000, the bank has effectively doubled the money in the economy, since Harry’s $10,000 is available to him and earning him interest in his account, while Hermione’s loan is purchasing her $9,000 worth of education.
Don’t forget the fees
Of course, the net interest margin is not the only way that banks and loan companies make money. Fees can also be a source of profit, and something that the consumer needs to be wary of. In particular, you are likely to see the following types of fees among loan companies:
When a borrower applies for a loan, he will often be faced with an application or loan origination fee. Sometimes you will pay this out-of-pocket, and sometimes the fee will be included in the principal of your loan, which means you will also be paying interest on it.
These fees are generally on the depositor and investor side. You might pay an account fee for a checking account, an investment account, or a credit card as a maintenance charge.
Using an ATM under another bank’s name will cost you. Often, you’ll pay a fee to the bank that owns the ATM, as well as a fee to your bank.
These fees generally occur when you do things like overdraw your account or make a late payment on a loan.
Even though some of what banks do may seem magical, it’s important for all consumers — both borrowers and investors — to understand the simple ways loan companies and banks make their money. Armed with this knowledge, you can recognize and avoid unnecessary fees and limit your interest payments.
Interested in refinancing student loans?Here are the top 6 lenders of 2018!
|Lender||Variable APR||Eligible Degrees|
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1 Important Disclosures for Earnest.
To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants will qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest fixed rate loan rates range from 3.89% APR (with Auto Pay) to 7.89% APR (with Auto Pay). Variable rate loan rates range from 2.47% APR (with Auto Pay) to 6.97% APR (with Auto Pay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms 10 years or less. For loan terms of 10 years to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 1.82% and 5.50% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of Month/Day/Year, and are subject to change based on market conditions and borrower eligibility.
Auto Pay discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 08/21/18. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice. Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 302 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, email us at email@example.com, or call 888-601-2801 for more information on ourstudent loan refinance product.
© 2018 Earnest LLC. All rights reserved. Earnest LLC and its subsidiaries, including Earnest Operations LLC, are not sponsored by or agencies of the United States of America.
2 Important Disclosures for Laurel Road.
Laurel Road Disclosures
APR stands for “Annual Percentage Rate.” Rates listed include a 0.25% EFT discount, for automatic payments made from a checking or savings account. Interest rates as of 11/8/2018. Rates subject to change.
Variable rate options consist of a range from 3.27% per year to 6.09% per year for a 5-year term, 4.64% per year to 6.14% per year for a 7-year term, 4.69% per year to 6.19% per year for a 10-year term, 4.94% per year to 6.44% per year for a 15-year term, or 5.19% per year to 6.69% per year for a 20-year term, with no origination fees. APR is subject to increase after consummation. The variable interest rate will change on the first day of every month (“Change Date”) if the Current Index changes. The variable interest rates are based on a Current Index, which is the 1-month London Interbank Offered Rate (LIBOR) (currency in US dollars), as published on The Wall Street Journal’s website. The variable interest rates and Annual Percentage Rate (APR) will increase or decrease when the 1-month LIBOR index changes. The variable interest rates are calculated by adding a margin ranging from 0.98% to 3.80% for the 5-year term loan, 2.35% to 3.85% for the 7-year term loan, 2.40% to 3.90% for the 10-year term loan, 2.65% to 4.15% for the 15-year term loan, and 2.90% to 4.40% for the 20-year term loan, respectively, to the 1-month LIBOR index published on the 25th day of each month immediately preceding each “Change Date,” as defined above, rounded to two decimal places, with no origination fees. If the 25th day of the month is not a business day or is a US federal holiday, the reference date will be the most recent date preceding the 25th day of the month that is a business day. The monthly payment for a sample $10,000 loan at a range of 3.27% per year to 6.09% per year for a 5-year term would be from $180.89 to $193.75. The monthly payment for a sample $10,000 loan at a range of 4.64% per year to 6.14% per year for a 7-year term would be from $139.65 to $146.76. The monthly payment for a sample $10,000 loan at a range of 4.69% per year to 6.19% per year for a 10-year term would be from $104.56 to $111.98. The monthly payment for a sample $10,000 loan at a range of 4.94% per year to 6.44% per year for a 15-year term would be from $78.77 to $86.78. The monthly payment for a sample $10,000 loan at a range of 5.19% per year to 6.69% per year for a 20-year term would be from $67.05 to $75.68.
However, if the borrower chooses to make monthly payments automatically by electronic funds transfer (EFT) from a bank account, the variable rate will decrease by 0.25%, and will increase back up to the regular variable interest rate described in the preceding paragraph if the borrower stops making (or we stop accepting) monthly payments automatically by EFT from the designated borrower’s bank account.
3 Important Disclosures for SoFi.
4 Important Disclosures for LendKey.
Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
5 Important Disclosures for CommonBond.
Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown.
All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate. All variable rates are based on a 1-month LIBOR assumption of 2.28% effective October 10, 2018.
6 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
|2.24% – 7.24%3||Undergrad & Graduate|
|2.47% – 6.97%1||Undergrad & Graduate|
|2.51% – 8.09%4||Undergrad & Graduate|
|3.02% – 6.44%2||Undergrad & Graduate|
|2.69% – 7.21%5||Undergrad & Graduate|
|2.79% – 8.39%6||Undergrad & Graduate|