One of the main places your wealth goes when it flows away from you is into the coffers of the banks and credit companies.

When you borrow money, you expect your bank to charge you interest until you pay back the loan. But you may not realise just how much profit this interest will make them.

One of the ways banks secure funds to enable them to lend to you is that they borrow money from other banks.

The rate at which banks can borrow is determined by the minimum rate set by the central bank, which in the case of the UK is the Bank of England.

The rate at which banks lend to and borrow from one another is linked to this and in the UK is known as Libor—the London Interbank Offered Rate. Libor is used as the reference rate for

many other currencies, while the Euribor is used in the Eurozone.

Often when you borrow money, the rate will be fixed as a certain percentage over this rate, which will be higher than the central bank base rate.

So, for example, when the Bank of England base rate is 1%, the Libor rate may be 2%. Consumer mortgages, for example, may be set at 1% over Libor.

Therefore, if the Libor rate is 2%, the mortgage rate could be 3%. (The actual mortgage rate paid depends on a huge range of factors but this keeps the example simple.)

The bank is effectively borrowing money at 2% and lending it to you at 3%. You might expect that this 1% margin is where they make their money. And you’d be right. Well, partly right.

Because if you are thinking their profit on that transaction is 1%, you may be shocked to discover the truth. The bank is making more. Much more!

The bank makes a proftt of 50%: The difference

between the 2% they pay and the 3% they get from you

is 50% proftt to them.

Let’s work that through:

You want to borrow £100,000.
The bank borrows this at 2% interest, so they pay £2,000 a year as the cost of borrowing.
You pay the bank 3% interest, or £3,000 a year, as your cost of borrowing.
The bank pockets £1,000 profit for selling a product that costs them £2,000 to acquire.

Pretty good business for them!

Of course they do have some costs to pay but they will probably have included some charges when you took out the loan and there is a pretty fat margin in that profit to cover their costs.

Now here is the really shocking part. The interest rates of most loans and credit cards are much higher than for mortgages. A typical credit card rate can easily be over 20%.

So when the bank is charging you 20% on your credit card debt and paying only 2% for the money, they are raking in profits of close to 1,000%

How good does that make you feel?

Can you see why the bank was so keen to give you a credit card and lend you money?

Believe it or not, they are not done yet. As I explained in the previous section, the bank can actually lend part of the same money over and over so they can multiply their profit many times.

At the same time, the bank may be paying you between 1% and 3% interest on your savings if you are lucky.

Have you ever wondered why banks manage to make so much money even in tough times?

Well, now you know.

31. How Banks Can Make 1000% Profit or More on Your Debts