This post is part of the textbook personal finance series which covers basic personal finance skills by going through an actual textbook, chapter by chapter. Check out the intro post for more information.
The current chapter is on savings and payment services. Once you have a plan for your money, it’s important to know where to put it to best achieve your goals. I found this list of types of institutions interesting because we often generalize about “banks” but don’t look into the differences between types of bank. Then there are other nondeposit institutions which provide various financial services.
These types of institutions take deposits from savers and lend them out to borrowers. What you put in is what you get back, often plus interest on savings accounts.
Commercial banks offer a full range of financial services—checking, savings, lending, and sometimes other things like investing. These banks are organized as corporations and run for profit. They have independent investors who provide the capital to keep the bank running and don’t necessarily save or invest their money in the bank.
Savings and Loan Associations
I first encountered S&L associations in books of political and other cartoons from the late 1980s through the early 1990s. The S&L crisis during that period seems to have been very similar to the current and far more widespread financial crisis. The ones that recovered generally went on to provide a full range of financial services.
Savings and Loan associations used to specialize in savings accounts and mortgage loans. They were more likely to be locally owned and their purpose was to encourage everyday people to save and help them buy homes. This actually reminds me if the “Building & Loan” company in It’s a Wonderful Life.
Mutual Savings Banks
Mutual savings banks are similar to S&Ls, but according to the book they are most likely to be found in the northeastern United States. Mutual savings banks are owned by their depositors, who receive the profits as higher rates on their savings accounts.
Credit unions are user-owned, nonprofit, cooperative financial institutions. Traditionally there was something about the members that held them together—workplace, place of residence, etc. Nowadays membership limitations are often geographic and they’re a lot looser than before.
Credit unions provide all kinds of financial services including credit cards, mortgages, home equity loans, and investment services. In many cases the credit union will offer lower fees and charge less interest on credit cards and other loans than a commercial bank.
The financial services provided by these institutions may also be provided by the types of deposit institutions listed above.
Life Insurance Companies
Life insurance is an investment to provide for your dependents. As such, it’s already a financial service. However life insurance companies have also begun expanding to provide savings, investment, and retirement planning services. Whole life insurance was already a kind of savings account with a contingency to pay out early if you die while still making payments on the plan.
Investment companies like Fidelity and Vanguard (and many many others) are places which manage your investment portfolio. Many of them offer mutual funds which allow you to invest in a variety of stocks/bonds/other investment vehicles at one time. Often to get a particular fund you have to invest with the company that runs it. In many cases, investment companies will offer the same traditional funds (such as an index fund that follows the S&P 500) which vary little between company as well as their own blends which you can’t find elsewhere.
These companies are in the business of lending, either to individuals or to small businesses. The book suggests that they often charge higher rates than lenders like banks. (But we’re not yet to the payday loan level.) These may be the people who hold your car loan, for example.
A lot of lending institutions offer mortgages. Mortgages companies deal (almost) exclusively in, well, providing loans for home-buyers.
Problematic Financial Businesses
These types of businesses provide financial services, but at exorbitant prices. Most of the time, they’re patronized by people who don’t have ready access to financial services at other places, whether because of where they live or because of their financial history.
Pawnshops make small secured loans based on the value of tangible possessions. They charge some interest, but if you don’t repay the loan at all they won’t come after you. Instead, after a pre-determined amount of time (normally a short period) they simple put your security up for sale and recoup the value.
If you don’t have an account at a bank, you probably can’t cash a check there. If the check is drawn on the bank, they may be willing to cash it if you have a great deal of ID (some even require a thumbprint). Therefore, people without bank accounts often use check-cashing outlets. You’re more likely to find them in lower-income areas.
They can charge anywhere from 1-20% of the check’s value, though 2-3% is most likely. Most check-cashing outlets advertise other services like money orders, postal boxes, wire transfers, etc. In a way, they function like high-fee banks.
In a typical payday loan, the borrower writers a check for the amount borrowed + interest and postdates it for a week or two. The lender then agrees to hold onto it and cash it on the appropriate date, by which point the borrower will have received their next paycheck. If consumers can’t pay, then may “roll over” their loans and pay even more interest.
Payday loans can end up costing over 1000% interest if they roll over and 780% or more even if they don’t.
Rent-to-own centers will sell or lease you a product which you can then pay for by completing a certain number of monthly payments. Otherwise, you can return it and get something else.
At first I was surprised to see them listed, but these centers actually do provide credit for items. If you plan to pay off your rent-to-own, then you’re essentially taking out a loan for the cost of the item and whatever you pay above that is interest. It’s not unlike buying a computer at Best Buy through installments and having that computer repossessed if you don’t pay it off.
One of the differences is that rent-to-own doesn’t necessarily spell out the payments in terms of interest. People have sued these centers for illegally charging 100% interest on furniture and appliances.
I plan to cut short the next section on savings, payment, and checking plans in order to focus on savings. Too much has happened to payment options and checking plans in the six years since the book was written. Many of the then-new internet services have become standard. The saving plans have stayed mostly the same.