# Little exercise

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From: Sergey Golovin

Here is some little exercise folks.

Let say average salary this days in Oz. \$34K? (According to Statistics).
Average house price all across the land \$180K?
It does not matter, do not worry of exact numbers, let say those are the figures.

Let say that average block with \$34K income buys \$180K property and he/she was lucky enough to borrow whole amount \$180K to buy it.

As we are all know house price doubles every 10 years.
Let assume that salary will double as well, very unlikely, but never mind, lets give to it him he deserved it.

Now, saying all that lets have look on final figure in 20 years time –
1. Salary 10 years \$34K x 2 = \$68K and next 10 total 20 years \$68K x 2 (doubles again) = \$136K. Lucky man. Salary quadrupled.
2. The house - \$180K x 2 = \$360K and another 10 (20 total) years \$360K x 2 = \$720K.

If that person borrowed \$180K as we mentioned earlier in 20 years time he/she will pay double of the amount borrowed (as you can see from repayments charts) - \$180K (principal) + \$200K (interest) = \$380K total paid at the end of year 20 (bit more then double, well, close enough).
In theory it should quadruple as well but it did not. It is only doubled.

Question is – How do banks make their money? Obviously it is very profitable business – lend money. But how do they get around that hurdle?

Folks, I am puzzled. Would be interesting to hear from someone more on that topic.

Regards
Serge G.

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From: Sergey Golovin

Thanks Michael.
You are right there.

I can understand, like in earlier days they did lend you money, but the term (time span of the loan) was much shorter probably - 5 years? So, they will recover their money and profit very quickly.
But these days the term gets longer and longer - 30 years and maybe more I do not know.

Well, it is interesting.

Thanks again.

Serge G.

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From: The Wife

Sergey,

5 years just isnt long enough today.

They need longer amounts of time, so that they can hook you into their web, and make you a "life partner" to the bank, they need longer time to make you give give give .

The way around that, is to KNOW and UNDERSTAND that this is what the bank is doing, and to make it work for you, via good debt, vs bad debt.

The bank can be an endless source of other peoples money, or it can be your life long nightmare, dont fall into credit card traps etc etc etc....

I just love the meaning of mortgage, I think its latin or french? somebody correct me

Mortgage means, "Engagement until death"

TW
~Life is a daring adventure, or nothing at all~

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From: Paul Zagoridis

Except that the1.5% margin on \$Billions is not 1.5%

If they borrow at 5% and lend at 6.5% they are making 30%

Also merchant fees on credit cards purchases run at 1.5% to 2.5% on every dollar.

Look at the prudential requirements for their different asset classes. Their margins on personal loans and other higher yielding assets like business overdrafts and bank bills mean their margins exceed 100%.

The multiplier effect also allows banks to create money

Dreamspinner

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From: Apprentice Millionaire

Hi TW,

>I just love the meaning of mortgage, I think its latin or french? somebody correct me please.
>
>Mortgage means, "Engagement until death"

Your french is spot-on! Until death it is!

Cheers
Apprentice Millionaire
(aka Jacques)

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Fractional Banking

From: Michael G

Hi,

You can also do some research on fractional banking.

It's one reason we have inflation and why the buying power of a dollar gets less every year.

I'm no expert but would love to hear this from an accountant.

Basically fractional banking as I understand it is the banks ability to lend money based on a small amount of real cash.

Ok, lets say someone desposits \$20. They give \$4 to the Reserve Bank as a security deposit. The RBA then allows then to lend \$96 dollars and they actually have \$16 dollars of cold hard cash to play on the bond markets to get a return.

So if you give a bank a 20% deposit for a home loan, who's money are you actually borrowing?, the banks?

Of course there are limits. Any bank managers here?, I would loved this clarified.

Michael

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It;s also called the Multiplier Effect

From: Paul Zagoridis

The multiplier effect is an old economic phenomenum

In the old days banks used to keep a % of their assets on deposit with the RBA to insure the integrity of the banking system.

How did banks start?

I'm a Swiss jeweller. I have the only safe in town, and I go drinking at the pub, paying with 100 pieces of gold.

Bob, the innkeeper comes and deposits his 100 gold with me. I charge him to store his gold, which is why Swiss banks used to have negative interest rates.

Now Bob comes around and withdraws some gold, deposits some. Be he never takes it all out at once. I've given him a book that records his current holdings in my safe. I keep a ledger of all the gold, mine and his.

Pete the Smith, needs a new anvil and borrows the money to buy it. I lend him some of Bob's actual gold. Bob continues to access some of his gold. But he doesn't know I've lent some of it out.

Pete's new anvil wins new business and Pete in addition to paying principal and interest, deposits his profits with me. It's all the same 100 physical gold pieces. But it grows as we store and lend it. It is now worth 180 gold pieces.

If everyone wanted their gold back at once, the would be a run on the bank (jeweller). BUT I'd call in Pete's loan and it would all eventually be square (except for transaction costs, and more importantly the wealth created by labour or capital).

Get the picture? Now multiply it and the complexity by a factor of a few trillion.

Dreamspinner (B.Ec)

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