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How to Be Your Own Bank

How to Be Your Own Bank

Introduction

With base rates at historical lows, many savers and investors are frustrated with the interest rates that are being offered by banks and other financial institutions.

In fact it will not surprise you to learn that a bank accounts its customers as it cheapest source of funds, offering less than half a percent on current accounts and up to a generous 3 to 4% on longer term savings and bonds.

With credit again starting to become tight between banks the London Interbank Offer Rate known as LIBOR is starting to rise well above the bank base rate. With the base rate at 0.5% 1 week Libor is now 0.91% and 1 year Libor is now 1.699%.

If you also factor in that inflation is running around 4% to 4.5% with the current interest rates being offered, savers and investors are losing purchasing power by holding their savings in the banks.

It used to be considered very safe to hold your money in a savings account, but as the current credit crisis has highlighted the banks are not as safe as savers once thought. Even though most governments around the world have guarantees in place to protect savers funds, it should be noted these guarantees only cover in the UK up to 85,000. This guarantee also only covers a financial group, therefore if your funds add up to a total above this amount across a number of institutions all covered by one banking license you are still running a risk.

Make sure your funds are in different banking groups. You can check which banks belong to which group at the FSA website. For example both RBS & Nat west are covered by the RBS banking license.

It should be remembered that income tax needs to be deducted from those very generous rates offered by the high street.

The Search for Alternatives

A lot of savvy investors are now looking for alternatives to the traditional high street bank or building society in order to reserve their capital against the ravages of inflation. Remember at a time of high inflation borrowers benefit at the expense of savers as the true value of their debt is eroded by inflation. The government wants this as it reduces the real value of the government debt and helps them manage the servicing of that debt.

What we have now is an environment where Governments around the world are in effect penalizing prudent savers and investors in order to help out the profligate spending of the government and domestic borrowers.

There are now a number of ways that individuals can now become banks themselves and cut out the traditional banks & building societies. It should be noted that these alternatives although paying a higher return do come with some form of risk either in terms of credit risk (ie the borrower defaults on their loan, a bit like Greece is about to do) or liquidity risk (ie you will do not have access to your funds for a given period of time)

The Growth of Peer to Peer Lending

This is a term that has been used in the press to describe borrowing and lending between parties that does not involve a traditional financial institution. Examples of which can be credit unions or some of the new internet based business such as Zopa.com

Zopa is an internet based business that matches up borrowers and lenders on its website, with the advantage of providing higher returns to lenders and lower rates to borrowers. Zopa takes a small commission between the two parties which is significantly lower than the running costs of a bank.

Zopa offers a number of different markets that the lender can choose from, they include the following:
• 36 month loans
• 60 month loans
• Credit score individuals A *, A, B & C
• Young people.

Interest rates on loans start at around 5.9% pa for a 36 month loan to an A * borrower to 9% to a young person for the same term.

60 month rates are slightly higher and start at 7% and go to 9.8%. The higher rates reflect the fact that your money is tied up for longer.

Zopa tries to manage the risk of default on loans by underwriting a detailed credit scoring on the borrower which is considered much more stringent than that approved by the banks.

Risk is also managed further by allocating your funds across a number of different borrowers so that if anyone defaults your loss is minimized. Zopa states that if you have over 500 in the system your money will be spread across over 50 different borrowers.

If you need to withdraw your funds prior to the lending period being completed, there is a facility to input a request to withdraw your funds. The system will match your withdrawal with another lender that wants to put their money into the system and that will enable you to withdraw your funds.

A Higher Return Alternative to Zopa

Traditionally Zopa is for smaller lenders who want to earn higher rates than those offered by the banks.

If you have an amount of over 10,000 to invest there are a number of better options out there where your return can achieve returns of 12% per annual.

A number of bridging companies borrow funds from investors at 1% per month and then lend to individuals and businesses at higher rates. The money is secured against the value of the property with the bridging company having a first charge on the property purchased.

In some cases the bridging company with take a floating charge over other assets of the individual or business if they do not feel there is sufficient security for the loan.

The bridging period can be for as little as a day normally up to 12 months with the average being 6 months. This is normally the period where a borrower can refinance with a mortgage and reduce their borrowing costs.

There are a number of companies in the market place that pay these attractive rates but, you must feel comfortable that the bridging company is well managed and there legal documentation is well written to protect the security of your funds.

It should be noted that a good bridging company will never expect you to deposit the funds in their account. The funds will normally go directly into an escrow account managed by a solicitor with the sole intent of lending against a particular property purchase. If a company asked you to transfer your funds into their account directly, DO NOT DO IT.

A well managed bridging company will have a number of transactions in the pipeline ie property investors interested to borrow funds as well as a number of investors of funds to match the amounts required.

Summary

With bank interest rates so low, investors are looking for better returns outside the traditional financial institutions. Before lending your funds to an alternative organization makes sure you understand the risks that you may be taking either through credit loss or liquidity. Read the legal documentation thoroughly and make sure you are comfortable with the terms & conditions.

I hope this article has opened your eyes to alternative investment opportunities, rather than leave your money losing value in the bank.

Source by Mark Skeels

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