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Checking accounts are virtually free loans
Buying deposits cheap
Banks buy deposits as cheaply as possible. Who else, besides the owner of a checking account, will hand-deliver cash on payday and charge only 0.07%? These are virtually free loans.
Savings accounts are a bank's second favorite kind of money. Banks pay a little more there, but by restricting access, such as limiting the number of monthly withdrawals, they ensure the money is available longer, which lets them safely lend it out.
Selling them high
Then comes selling high. Banks turn around and sell deposits to borrowers at a much higher interest rate, and the average 30-year home mortgage now costs about six and a half percent. The difference between what a bank pays for money and what it earns from it is called its net interest margin.
Even a tiny bank can keep the lights on this way: 6.5% minus 0.07% is a lot of percent, especially when multiplied by millions of dollars in deposits.
Why do banks limit savings withdrawals?
For decades, a Federal Reserve rule called Regulation D capped the number of convenient withdrawals and transfers from a savings account at six per month. The rule existed because reserve requirements treated savings accounts differently from checking accounts, and the cap kept savings accounts from acting like checking accounts. The Fed removed the six-per-month limit in 2020, after it dropped reserve requirements to zero.
Why can banks lend out deposits?
Banks keep only a fraction of deposits as cash because depositors rarely all withdraw on the same day. The practice goes back to seventeenth-century London goldsmiths, who began lending out part of the gold left with them for safekeeping. The risk is a bank run, when too many depositors ask for their money at once. Congress created the Federal Deposit Insurance Corporation in the Banking Act of 1933, and it began insuring deposits in 1934.
What sets the rate on a mortgage?
Mortgage rates track the yield on long-term government bonds, especially the 10-year Treasury, because investors who buy mortgage debt compare it with that safer alternative. Lenders add a spread on top to cover risk, servicing costs, and profit. The Federal Reserve's policy rate influences mortgage rates indirectly, through its effect on expectations for future short-term rates. Freddie Mac has published a weekly survey of average mortgage rates since 1971.
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