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Have you ever wondered how in the world banks 
make
SO MUCH MONEY??
Let me walk you through it step by step
THREAD
make
SO MUCH MONEY??
Let me walk you through it step by step
THREAD
We're going to tell a story of 3 players in this game of life:
Sam the Saver
Bob the Banker
Bill the Borrower
Sam the Saver
Bob the Banker
Bill the Borrower
And this thread is going to give a real life example, using real numbers, over 5 years
Let's get started
Let's get started
Sam, following what he knows to be the conventional financial advice, decides to save $20,000 he has earned as income from working his job
He places his $20,000 into a savings account with Bob the Banker
He places his $20,000 into a savings account with Bob the Banker
According to the FDIC, as of this writing, the average savings account interest rate right now is 0.06%
Sam is going to be a good saver and leave that money there for the full 5 years of this example
Sam is going to be a good saver and leave that money there for the full 5 years of this example
Now we enter the realm of Bob the Banker
Banks in the US follow what is known as a fractional reserve lending protocol
This sounds scary. Let me break it down for you
Banks in the US follow what is known as a fractional reserve lending protocol
This sounds scary. Let me break it down for you
The idea behind savings accounts is that we don't expect people to withdraw all of their savings at once
As such, the federal government doesn't expect a bank to be able to do that if someone wants to
As such, the federal government doesn't expect a bank to be able to do that if someone wants to
They allow the banks to actually lend out ALL OF YOUR MONEY so that they can make loans to other people
Sound like a scam to you? Just wait! There's more!
Sound like a scam to you? Just wait! There's more!
The government takes it a step further and actually gives them the power to make loans worth MORE than they have in deposits
For every $10 deposited with a bank, they are only required to be able pay out $1 if every single one of their customers decides to withdraw their deposits
This is their "fractional reserve", hence the name
This is their "fractional reserve", hence the name
Where do they get all this money to make their loans, you ask?
From the federal government of course!
From the federal government of course!
So Bob the Banker decides to be a good gear in the machine and makes a nice big loan, holding Sam's deposit as his fractional reserve
The fractional reserve rules allow him to make a $200,000 loan to Bill the Borrower
The fractional reserve rules allow him to make a $200,000 loan to Bill the Borrower
Bill the Borrower needs a $200,000 loan to buy a house
Let's say the agreement between him and Bob is a standard 30 year fixed rate mortgage
The average rate for these mortgages right now is 3.55%
Let's say the agreement between him and Bob is a standard 30 year fixed rate mortgage
The average rate for these mortgages right now is 3.55%
This brings Bill the Borrower's monthly payment, and Bob the Banker's monthly income, to $903.68
But keep in mind Bill will also be paying closing costs to acquire this loan
Closing costs will run 2-5% of the loan amount. We'll just low-ball at 2% for now, so that's $4,000
But keep in mind Bill will also be paying closing costs to acquire this loan
Closing costs will run 2-5% of the loan amount. We'll just low-ball at 2% for now, so that's $4,000
Bill is a good borrower and he makes his monthly payments to Bob for 5 years before selling his house to move on to something else
Here is where we're going to stop this example and take a snapshot to see how each of our friends are doing
Here is where we're going to stop this example and take a snapshot to see how each of our friends are doing
Sam the Saver looks at his bank account balance to check on the fruits of his labor
His balance?
$20,607
So he is in the green by $607
His balance?
$20,607
So he is in the green by $607
However, we need to keep in mind that these are nominal balances
Something called inflation has been eating away at Sam's purchasing power
The inflation rate right now is ~2.5%
Something called inflation has been eating away at Sam's purchasing power
The inflation rate right now is ~2.5%
This means that $20,000 worth of groceries when we started this example would now cost ~$22,628
So despite saving his hard earned money, Sam can now afford 9% less than he could afford with his money 5 years ago
So despite saving his hard earned money, Sam can now afford 9% less than he could afford with his money 5 years ago
Now let's look at Bill the Borrower. We'll ignore any changes in the price of his house to isolate the banking in this example
In general, real estate appreciates, but it cannot be predicted with certainty
We will only use concrete, predictable numbers in this example
In general, real estate appreciates, but it cannot be predicted with certainty
We will only use concrete, predictable numbers in this example
"Buying a house is great!"
Or so they say... Under the pretense that some of your monthly payment is being used to pay down the amount you owe on your loan
But just how much has Bill actually paid down? Let's take a look
Or so they say... Under the pretense that some of your monthly payment is being used to pay down the amount you owe on your loan
But just how much has Bill actually paid down? Let's take a look
At the end of year 5, Bill has made
60 payments of $903.68
Totalling $54,220.80
BUT
He still owes $179,175 to the bank
MEANING
he only paid $20,825 worth of principal
And paid $33,395 worth of interest!
60 payments of $903.68
Totalling $54,220.80
BUT
He still owes $179,175 to the bank
MEANING
he only paid $20,825 worth of principal
And paid $33,395 worth of interest!
For every dollar that was applied to the principal, Bill breaks even on
So Bill walks out of these 5 years having paid $33,395 in interest plus $4,000 in closing costs, to the bank
He is in the red by $37,395
So Bill walks out of these 5 years having paid $33,395 in interest plus $4,000 in closing costs, to the bank
He is in the red by $37,395
Now on the flip side, Bob the Banker is in the GREEN by the same amount, less all of the interest he paid to Sam the Saver
Bob is in the green by $36,788
Bob is in the green by $36,788
So let's recap how everybody made out:
Sam: +$607, but with an overall loss in purchasing power. In other words, Sam is a LOSER
Bill: -$37,395 although he did get a place to live, he is still a LOSER
Bob: +$36,788
THIS SYSTEM IS RIGGED IN BOB'S FAVOR
What are the takeaways?
Sam: +$607, but with an overall loss in purchasing power. In other words, Sam is a LOSER
Bill: -$37,395 although he did get a place to live, he is still a LOSER
Bob: +$36,788
THIS SYSTEM IS RIGGED IN BOB'S FAVOR
What are the takeaways?
Saving = LOSING! You can't let your money sit around in a bank account Borrowing to pay for personal items = LOSING! Leveraging and investing = WINNING! Taking advantage of the systems available to you = WINNING!END THREAD
Let me know if you learned anything!
I'm gonna use this to plug my man @ChroniclesNate course! He'll teach you more about this concept and how to use it in your favor.
I've been working personally with Nate and learning a ton from him. The value is unmatched!
Check it out here:
https://zorban.krtra.com/t/FPJR5BQ2Dn9c
I've been working personally with Nate and learning a ton from him. The value is unmatched!
Check it out here:
https://zorban.krtra.com/t/FPJR5BQ2Dn9c
