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How Banks Work
Let's say you deposit your money in a savings account. The bank will pay you for every dollar you keep in your savings account. The money the bank pays you is called interest. How much the bank pays can change from month to month.
The amount the bank pays is talked about as a percentage. If the bank is paying 3% interest, the bank will pay you 3¢ for every dollar you deposit in your account. Why does the bank pay you? The bank wants to use your money to make loans – that is, lend people money. People often borrow money from the bank to buy expensive things, like houses and cars. Here's how it works.
Great Uncle Henry, who has always liked you, gives you $5,000 to start a college savings fund. You put the $5,000 in a savings account that pays an interest rate of 3%. At the end of one year, you now have $5,150. The bank paid you $150. If you leave your money for another year, you will earn interest on the new balance of $5,150 ($154.50) and reach a new balance of $5,304.50. Neat, huh?
But at the same time you deposited your $5,000, your neighbor needed a $5,000 loan to buy a car. She went to the bank for a loan, and the bank charged her 9% for the money. By the end of the year, your neighbor had paid the bank $450 in interest.
Banks earn profits
The bank made $300 by loaning money – even after paying you $150 in interest. So banks make their money by working with both savers and borrowers.
Savings are safe
Don't worry – whenever you give money to a bank, the federal government insures it. Up to $250,000 in your account is protected by the federal government. It's very safe.
If you leave your money in savings
Let's say that Uncle Henry gave you the money when you were 10, but told you that you couldn't withdraw any of the money until you are 19 and ready to go to college. At 3% annual interest you will have $6,523. 87! But you don’t need a big gift to get you started. Use the Compounding Calculator to see what will happen if you save on a regular basis. Have fun!.
Checking accounts are not savings accounts. You do not earn interest on most of these accounts. You use checking accounts to hold money to cover common expenses. Learn more under Cash, Check or Credit? in the Spending section.