Did you know that your bank loves its customers being in debt? That’s because debtors have to pay interest and that’s one of the main ways in which the bank makes money. So, being in a manageable level of debt makes you a good customer.
Understanding how banks work
To help with understanding how banks work, it helps to think about how they operate as a business, with money as the product. It’s not that different from making a widget. The ways banks make money include supplying their product for more than it costs them to buy. Banks “buy” money by borrowing it. When you deposit money in a bank account, you’re lending that money to the bank. It pays you interest in return for having the use of your money. To make money, it lends that money to people, businesses and government organisations and receives interest. It’s just that the interest is higher than the amount it’s paying to savers.
Tip: Banks, like any business, can be negotiated with.
Ways banks make money: the basic widgets they sell
These are the basic widgets (products) that banks sell, which shows some of the ways banks make money:
This was the earliest type of account offered by banks before new advancements, such as chequebooks and credit cards came along. You simply deposit your money into savings accounts and leave it there until you need to take it out. The bank usually pays you interest on a daily, weekly, monthly, or annual basis. However, keep in mind that savings accounts can be restrictive and often charge high fees as a way of deterring you from taking out money. Some savings accounts specify that you have to keep a certain amount of money in the account per month to receive the total interest rate.
These accounts called “cheque”, “current” or “transaction” accounts are the place that you keep your day-to-day money. You take it out at the ATM with a card, use EFTPOS to spend it at shops and businesses, transfer online to other accounts, or write a cheque. Banks typically pay little or no interest on these accounts because they’re providing you with a service you need.
If you agree to lock up your money from one month to five years, the bank will pay you a higher rate of interest on your savings. On 11 August 2016, the Reserve Bank of New Zealand lowered the Official Cash Rate to 2%. Traditionally, this would mean bad news for savers, as banks would pass on the full rate cut to borrowers and interest rates on Term Deposits would be lowered. However, this time, Westpac and ANZ have increased some of their Term Deposit rates.
Pies are simply savings accounts or term deposits that are taxed more favourably than your regular account. For example, if your Pie account pays 3.30% interest, you’ll get the equivalent of 3.44% if you’re a 30% tax payer and 3.6% if you‘re on a 33% tax rate. Pie stands for Portfolio Investment Entity.
Need to buy now and pay later? With a personal loan the bank lends you money and you pay interest in return. Personal loans are often used to buy cars, set up a flat, move house, pay for school fees and many other purposes. Usually, you need to pay the loan back over three to five years.
These are quite literally giant personal loans. They’re also called mortgages. Providing you have a deposit – usually at least 20% – the bank will lend you all of the rest of the money you need to buy the home and you pay interest on the loan. Usually you’ll pay the money off bit by bit each month over 25 years.
Revolving credit mortgages:
These are clever mortgages that offset the money in your current account or other savings accounts against your mortgage. When your pay is credited at the beginning of the month the outstanding debt is reduced. You use the mortgage as a current account. But because your loan was reduced at the beginning of the month you pay a little less interest than you would have and this adds up over time.
Our little plastic friends allow us to buy goods before we earn the money to pay for them. We pay interest on the money we spend – after the interest free period of around 55 days – is up. Remember, not everyone carries a credit card balance. Plenty of my Gen-X friends think credit cards are bad. There are some, who use them solely for the reward points and always pay the balance in full each month. It’s also possible to get debit cards that still allow you to buy goods online, without getting into debt.
When you decide you want to switch banks
Sometimes, after doing your research on bank rates and being well-versed in understanding how banks work, you might decide you want to switch providers. Like breaking up with your hairdresser, the thought of it can be daunting, so here are some tips on how to go about it when you give your new provider the authority to make the switch.
Your new financial institution will provide you with a Switching Bank Request Form, which asks for:
Understanding how banks work: when you want to switch
If you want to carry out the bank switch process yourself, you can find out more to do that here. However, the good news is that people are generally happy with their current provider. According to a Canstar Blue survey of more than 2,500 New Zealand adults in April 2016, overall we’re satisfied or highly satisfied with our banking partner.