Mortgage money – where do banks find the money to lend to you when you enter into a mortgage contract? Do you actually “borrow” money from the bank’s depositors, or does the bank magically “create” money?

When you take out a mortgage, you’re essentially entering into a financial agreement with a bank or a lending institution to “borrow” a large sum of money to purchase a home.

Let’s just think about the word “Borrow” for a moment…

Section 912A(1)(a) of the Corporations Act 2001 (Cth) (Corporations Act) requires a financial services licensee to ensure the financial services covered by its licence are provided efficiently, honestly and fairly.

And let’s also think about the word “Honestly” …

For a breach to occur, the licensee must fail to “do all things necessary” when ensuring the financial services are provided efficiently, honestly and fairly.

In ASIC v Westpac, Judge Allsop states the obligation to act efficiently, honestly and fairly can “apply in an infinite variety of circumstances.”

Judge Beach agrees with this analysis, stating in ASIC v AGM Markets, the obligation to act efficiently, honestly and fairly is “to be applied to an infinite variety of corporate delinquency and self-interested commerciality.”

Deceptive Mortgage Money

“Deception” is an act or practice with the tendency or capacity to mislead a substantial number of consumers as to a material fact or facts.

Under the Australian Consumer Law (ACL), businesses must not engage in unconscionable conduct, when dealing with other businesses or their customers.

“Unconscionable conduct” is generally understood to mean conduct which is so harsh that it goes against good conscience.

For example, Australian courts have found transactions or dealings to be ‘unconscionable‘ when they are deliberate, involve serious misconduct or involve conduct which is clearly unfair and unreasonable.

The ACL is found in Schedule 2 of the Competition and Consumer Act 2010 (Cth). Section 18 of the ACL provides:

“A person must not, in trade or commerce, engage in conduct that is misleading or deceptive or is likely to mislead or deceive”.

The legal definitions of misleading and deceptive conduct match their plain English meanings. So, you can often assess whether a situation amounts to misleading and deceptive conduct by applying common sense. Under law, this means:

  • Remaining silent in circumstances where there is a reasonable expectation of disclosure.
  • Providing half-truths or incomplete information.

Ask yourself, would this conduct lead someone to believe something that isn’t true? If so, you might be engaging in misleading or deceptive conduct.

The other party does not have to prove that your conduct led to their error. Instead, they need to show that your conduct was objectively misleading. A court would decide this by considering whether someone in the same situation would likely be misled.

Yet, funnily enough – in relation to the banks – stating that we are “borrowing” money, when in reality it is “created”, is not deemed to be deceptive.

Why is that?

Mortgage money

The process of where banks get the money to “lend” against your mortgage is a bit complex, but can be broken down into a few key components.

Firstly, banks do not lend out money that they physically have sitting in a vault. Instead, they rely on a combination of existing funds and the ability to create new money through a process called fractional reserve banking. Here’s how it works:

1. Deposits:
Banks primarily fund their lending activities through the deposits made by their customers. When you deposit money into a bank, you’re essentially lending it to the bank.

[In reality, you’ve handed over your hard-earned cash to the banksters, and they can do with it as they wish. Once the moolah is in their hands, it’s not yours!

Again – in what way is that NOT misleading or deceptive? Don’t you assume that “your money” is being safely looked after by the bank?]

Banks are required to keep only a fraction of these deposits on hand (hence the term “fractional reserve banking”), which allows them to use the rest to lend out to borrowers, including for mortgages.

2. Reserves:
Banks are also required to hold a certain percentage of their deposits as reserves, which are kept either as physical currency or as deposits with the central bank.

These reserves serve as a cushion to ensure that banks can meet withdrawal demands from depositors and maintain stability in the financial system.

3. Lending and Creation of Money:
When you apply for a mortgage and are approved, the bank creates new money in the form of a loan.

This newly created money is typically “deposited” into your account or paid directly to the seller of the property.

Fractional Reserve Banking

[Note: How come this is called “lending” money? Does the “ordinary man or woman on the street” believe that the money you “borrow” comes from other depositors  funds?]

[In reality – these are just figures being shuffled around in accounting ledgers – no real “hard-earned benjies” are harmed in the transaction]

The bank’s ability to create money through lending is based on the fractional reserve system. Here only a fraction of the total deposits needs to be held in reserve.

4. Interest Rates:
Banks charge interest on the loans they provide, including mortgages. This interest is one way that banks generate revenue from lending activities.

[Note: Charging interest to “lend” you money that didn’t exist – Huh?]

The interest rates charged on mortgages are influenced by various factors. Things like the central bank’s monetary policy, inflation, economic conditions, and the borrower’s creditworthiness.

[But the money didn’t exist before the borrower came along – So what risk is there to the bank? What does the bank lose in the event that a customer doesn’t pay back something that wasn’t there to re-pay in the first instance?]

5. Secondary Market:
After originating a mortgage, banks often sell these loans on the secondary market to investors. Or government-sponsored enterprises (e.g., Fannie Mae and Freddie Mac) or other financial institutions.

By selling mortgages, banks can replenish their funds and continue lending to new borrowers.

So, in summary, when you take out a mortgage, you’re borrowing “money” that is:

  • partly funded by existing deposits and reserves but also
  • partly NEVER EXISTED, and was created by the bank through the lending process.

This creation of money is a fundamental aspect of modern banking. It allows banks to facilitate economic activity by providing loans for various purposes, including purchasing homes.