Finance: What is the Process of a Bank Loaning Money?

What is the process of a loan? Collateral. Do you have it? The bank lending you money wants to be sure that A) they get paid back, and B) they charge you enough rent or interest on the money you are borrowing such that it matches the risk the bank is taking.

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Transcript

00:26

that and then there's two. if you don't pay back the loan you promise to pay

00:31

back then which of your assets can they take from you, so that they get their

00:36

money into the interest you were supposed to pay back .okay example time [Man carries money in front of a for sale sign]

00:40

you're buying a house first one. you scrimped you save and now you think you

00:45

can afford this half-million dollar home in palo alto. and that's what half a

00:49

million bucks buys you here. well you have 50 grand in savings ready to put

00:53

down on the house, and you have a nice job as a personal trainer to the stars [man smiling in a gym]

00:55

of Silicon Valley, they look a little different from the stars of Hollywood. so

01:01

yeah you'll never be out of work. you make about 70 grand a year but it's all

01:04

as an individual contractor, so you have great periods of time where you make

01:09

bank and then months where you make a whole lot of nothing. well after taxes on

01:14

average your seventy K is about 50 K which is all you've got to your name. you [math equation]

01:19

thought you'd put 10% down, but didn't realize that you'd have to pay real

01:24

estate taxes in advance, and then other closing costs so you really needed

01:29

$60,000 but the bank wants your business

01:29

mainly because, well, their biggest [businessman talks to man in gym]

01:33

customers are your clients. prevailing interest rates on mortgages are 6% but

01:38

you're not exactly a Bill Gates credit risk, so your cost of interest will be

01:43

higher. they quote you an 8% mortgage rate if you put 20% down on the house.

01:48

but you don't have 20% to put down. you have way less, which means more risk to

01:54

the bank,and lending you the money meaning it's higher risk that they don't [equations shown]

01:58

get paid back, so they'll charge you more for renting the money from them. so the

02:02

price they charge you is 10% interest to rent the money because well you have to

02:06

pay for insurance, or PMI. that covers you if you don't pay them back. and yes that

02:12

sounds harsh and cruel, but well welcome to the real world. so you're

02:16

thinking that you have a loan of 460,000 dollars that extra 10 grand covers

02:21

closing costs and taxes and other things like maybe a little furniture a place to

02:26

sleep on. on 10 percent interest you'll pay 46 thousand dollars a year just in [equations]

02:31

interest. well essentially all of that interest is directly tax-deductible so

02:36

instead of your seventy thousand dollars being fifty thousand after taxes, as far

02:40

as the IRS is concerned ,you no longer make seventy thousand dollars you make

02:45

seventy thousand dollars minus forty six thousand dollars, or just twenty four

02:49

grand a year ,and your taxes on that are like that two grand maybe even a little

02:53

less .you almost qualify for food stamps. and that's good you might need them, [man chews on food stamps]

02:57

because two grand will just barely pay for the food you'll need to, you know

03:02

live. so the bank just barely passes you to qualify for this loan after checking

03:08

to be sure that you know you've never had a missed payment on a credit card, or

03:12

any other loan, or had any other issues like a DUI or some criminal thing that

03:17

would give any lender a cause to pause. so the above is all about your ability [checklist shown]

03:22

to pay that was number one. right number two what comes next is all about the

03:26

risk to the bank. you bought a home in a very active real estate market. the bank

03:32

presumes that they can always sell the home but the home is doubled in value in

03:36

the last three years, and the bank knows that this rate of appreciation is not

03:39

normal. so there's a lot of risk if the home drops in volume 30 40 maybe even 50

03:45

percent in the short run so there is a scenario where the home you just bought

03:49

for five hundred grand ends up selling for 300 grand less 20 [boxes and for sale sign]

03:55

grand in commissions and costs and that's only 280 G's. well the bank loaned

04:00

you four hundred sixty thousand dollars and in this scenario you'd of course

04:04

lose the fifty thousand dollars you put down at your down payment, but the bank

04:08

would then lose a hundred eighty thousand dollars as well. and you know

04:12

banks don't like to lose money. at least the ones that do don't stay in business

04:17

very long. yeah. so that's the process pay your loans. [ group smiles in front of Christmas tree]