Finance means borrowing money to pay for something, usually with interest and set repayment terms. Financing allows you to buy or pay for things that you may not be able to afford all at once with cash.
Key Takeaways
| Term | Definition |
|---|---|
| Financing | Borrowing money to purchase something with set repayment terms |
| Interest | Amount charged on financed money as a fee for borrowing |
| Down payment | Initial partial payment towards a financed item |
| Monthly payments | Set regular installments paid to repay a financed amount |
| Term length | Total duration given to fully repay a financing agreement |
Financing can refer to financing a vehicle, home, education, medical procedure, or other large expenses. The main benefits of financing include the ability to buy needed or desired items you currently don’t have full cash funds for, and spreading repayment over months or years to align with your budget.
The main aspects of financing to understand are:
- Interest rates and fees
- Monthly payment amounts
- Down payment requirements
- Term length options
Reviewing these key details allows you to choose affordable financing options for your specific situation and budget.
What Does “Financing” Mean?
Financing refers to borrowing money in order to purchase something, with the repayment occurring over a set period of time through a credit agreement. This contrasts with buying outright with cash upfront.
Some key financing definitions include:
- Loan: Money borrowed from a lender that must be repaid with interest
- Interest: An amount charged on borrowed money as a percentage of the total, paid as a fee for being allowed to borrow funds
- Down payment: An initial partial payment made when financing to reduce the amount borrowed
- Term length: The amount of time given for repayment of the borrowed amount
- Monthly payments: Set regular installment payments, usually monthly, paid towards repaying the financed amount
In most cases of financing, you agree to a regular monthly payment schedule until the borrowed principal plus interested is fully paid off. The repayment structure allows you to budget for the purchase over months or years.
Why Do People Finance Purchases?
There are several reasons consumers opt to finance instead of paying full cash upfront:
- Buy needed or desired items now: Finance when you need something now but don’t currently have the full funds saved up, like a reliable car for work or medical procedure. This allows you to buy essential items when you need them instead of waiting.
- Align with budget: Monthly finance payments may fit better with your income and budget compared to one large lump sum payment. This helps you affordably cover costs over time from ongoing paychecks.
- Build credit history: Handling financing responsibility can help demonstrate you can manage diverse credit types and repay debt over time. This in turn helps build your overall credit score to qualify for future loans and better rates.
- Leverage now against future earnings: You may reasonably expect your income to rise over the coming years. Financing leverages some of that future earning ability to purchase vital items or investments now at today’s prices.
The ability to finance expensive necessities or helpful items provides flexibility in optimizing major purchases for your household and lifestyle.
What Are Pros and Cons of Financing?
Financing has several general advantages but also comes with drawbacks to weigh:
Pros
- Purchase important items now
- Spread repayment over months/years
- Flexible term lengths
- Owning an asset during repayment
- Can help build credit history
Cons
- Pay interest fees over time
- Debt responsibility taken on
- Risk of default if payments missed
- Interest means more paid than cash price
- Penalties for late or missed payments
Assessing your personal financial situation is key for determining if benefits outweigh the costs based on your own needs.
What Factors Affect Financing Terms & Options?
Several elements directly impact what financing offers will be available to you and influence the rates and fees charged:
Credit Score
Higher credit scores signal lower lending risk. This translates to increased chances of approval and lower interest rates offered. Maintaining at least a good credit score expands financing options.
Income Level
Your income level and employment status are factored in by lenders to assess your ability to manage payments. Higher and steadier incomes may qualify for larger financing amounts and better rates.
Existing Debt
Too many outstanding loans or overusing financing can overwhelm your budget. Keeping debt and monthly obligations at reasonable levels relative to your income helps loan qualification.
Down Payment Size
The more you can pay as a down payment upfront, the lower the amount that needs financed. This leads to getting approved for more favorable interest rates from lenders.
Asset Type
Interest rates can vary considerably depending on what item you are financing – auto loans, mortgages, personal loans, etc. Each asset type has unique risks that set base rate ranges.
Evaluating your overall financial health using these key aspects provides a clearer picture of financing offers actually available to you.
What Are Some Common Things People Finance?
Some of the most common large expenses that consumers finance include:
Vehicles
- Car loans
- Auto leases
- Motorcycle loans
- Boat financing
Vehicles are commonly financed because they are expensive but offer utility and often needed for work and daily life. Loans allow people to access reliable vehicles by managing payments.
Homes
- Mortgages
- Refinancing
- Home equity loans
- Remodel financing
Major property costs like purchasing real estate or renovations are prime examples of expensive essential items financed over 15-30 years. Very few buy property outright in cash.
Education
- Student loans
- Tuition financing
- Computer leases
Given education’s high costs but high return later in earning potential, student loans facilitate investment into degree programs paid back over years.
Medical
- Health insurance
- Medical procedures
- Dental work financing
- Hearing aids
- Corrective vision financing
Healthcare regularly requires major one-time expenses, which medical-specific payment plans help manage through predictable installments.
Other
- Appliances
- Furniture
- Legal fees
- Weddings
- Funeral costs
Lenders finance nearly any major purchase that households require or prioritize but may not currently have full cash available for. This allows custom financing solutions.
As you evaluate routine or unexpected major costs you are facing, understand that financing options likely exist to make the expenses more affordable through structured repayments over 6 months to multiple years.
What Steps Are Involved in Getting Financed?
If you determine financing is the right approach for a major purchase, the main steps are:
1. Check Credit Score
Review your current credit score and reports to understand your starting point for lenders’ risk assessment. Also identify any errors to correct or credit tips to improve your profile.
2. Estimate Costs
Research the estimated total price for what you are looking to finance, accounting for taxes, fees, accessories, and any other expenses beyond the main item’s base cost. This determines how much you need financed.
3. Secure Financing Pre-Approval
Many lenders offer pre-qualified estimates indicating loan amounts, rates, and terms you should actually qualify for based on your financial profile. Compare options from multiple competing lenders.
4. Shop & Negotiate Price
With financing pre-approved, you can identify the specific item to purchase and negotiate the best price, knowing financing is already handled.
5. Finalize Financing Terms
Return to your selected lender with the final negotiated total purchase amount to adjust and finalize loan details like term lengths, payment schedule, etc.
6. Sign Agreement & Complete Purchase
Review all financing agreement documents in detail, securing your best understand of the commitment. Then sign paperwork to complete the lending transaction and associated purchase.
While every purchase situation is unique, following these general steps helps ensure you get approved for optimal financing terms and complete major projects affordably.
What Questions Should You Ask When Considering Financing?
As you navigate the financing process, key questions to clarify with lenders include:
- What is the interest rate and does it vary over the term?
- Are there any origination, application, or administration fees?
- How much is needed for a down payment to get approved?
- What credit score or debt-to-income ratio is required?
- How long are the allowable financing term length options?
- Is there a penalty fee for prepaying or will prepayments reduce total interest owed?
- Are extra payments permitted to pay off early?
- What are exact payment due dates and protocol for late payments?
- What happens if payments are missed – extra fees, higher interest, loan default?
Getting clear written answers to these critical questions allows you to make an informed decisions about whether a lender’s financing options match your needs and ability to repay commitment. Don’t hesitate to ask clarifying questions upfront before signing.
Here is Part 2 of the article on “What does it mean when you finance?”:
Critical Aspects That Determine Affordability
When considering financing, the most important factors that determine whether borrowing for a particular purchase is affordable and prudent for your budget are:
- Interest rates
- Fees
- Monthly payment amounts
- Down payment sizes
- Term length
Evaluating these key details allows you to select financing options that align with your income, expenses, and financial goals.
Interest Rates
Interest is essentially a fee the lender charges for lending you money. It is stated as an annual percentage rate (APR) of the loan amount. The higher the interest rate, the more paid in total fees over the full repayment term.
- Compare rates across multiple competing lender to find the most favorable rate for your situation
- Good credit scores qualify for the lowest rates – a major advantage of strong credit history
- Prioritize agreeing to the shortest term length you are able. This minimizes costly interest accumulation.
Fees
Beyond base interest costs, lenders may charge fees for processing applications, originating new loans, or administering financing accounts. Minimize fees to reduce total costs.
- Avoid lenders tacking on excessive ancillary fees wherever possible
- Don’t acquire new financing too often, as application and origination fees add up
- When able, provide a higher down payment amount to reduce the fees applied to the amount financed
Monthly Payments
The monthly installment amounts owed should align with your realistic budget after other obligations. Avoid overextending monthly finances.
- Use online loan calculators to estimate payments ahead of time based on potential rates, terms, and the amount you plan to finance
- Get the loan term length that provides affordable payments fitting your recurring income
- You can request quotes showing monthly payments as you adjust variables to visualize impact
Down Payments
Making a more substantial down payment upfront serves multiple advantages:
- Allows you to finance less principal, reducing the total interest owed over the loan term
- Signals the lender greater commitment, improving changes of approval & better rates
- Builds immediate equity in the asset to cushion against declining value vs outstanding loan balance
- Creates flexibility to refinance remaining balance for better rates in the future after building more equity
While coming up with larger down payments can be challenging, the long run benefits make it well worth striving for if at all feasible. Even an extra 10% down can improve financing terms notably.
Term Lengths
Opt for the shortest term length practical that allows affordable payments each month. Longer terms may seduce with lower monthly dues but end up significantly more expensive long term after interest.
- For major assets expected to be used for years like vehicles and homes, match term lengths to realistic usable lifespans
- Minimize interest fees by avoiding financing small, depreciating items over extremely lengthy terms
- Review amortization schedules to understand exactly when you will achieve ownership for major assets
Carefully weighing each of these essential factors provides the basis for sound financing decisions optimized to your personal financial situation.
What Are Signs of Predatory Financing Practices to Avoid?
While legitimate lenders provide reasonable financing to consumers with appropriate credit standards and risk controls, some unethical institutions offer misleading credit products with predatory practices. Be alert for warning signs of these to avoid:
Excessive Interest Rates
Legitimate lenders price interest rates based on market conditions and your financial qualifications. Be wary of rates drastically above the average for a given credit score tier with no justifiable reason.
Pressure Sales Tactics
Predatory lenders try convincing you to agree to deals on the spot before comparing options. Reputable financing allows time for consideration of terms and alternatives.
Obfuscated Cost Details
Deceptions hide elements like fluctuating rates and backend fee triggers in convoluted contractual fine print. Ethical lenders present clear rate and cost estimates upfront.
Requirement for Unneeded Products
Some financing agreements force you to purchase ancillary services like insurance you don’t need to boost lender profits. Legitimate loan approval is not contingent on these tacked-on add-ons.
Outsized Balloon Payments
Beware terms with overly generous payment schedules on the front end masking much larger balloon payments required at the end of the term after excessive interest builds.
Staying informed, doing careful research, and asking questions protects against predatory financing offers structured to mislead consumers into expensive deals ultimately unaffordable.
Final Key Takeaways on Financing
- Consider both benefits and drawbacks when weighing financing major purchases
- Assess key variables like interest, fees, and payments to determine affordable options
- Follow essential steps like checking credit and securing pre-approval to optimize the process
- Ask lenders clarifying questions to confirm complete understanding before signing agreements
- Avoid financing deals employing manipulating or deceptive sales tactics
Overall, handling financing judiciously allows prudent leveraging of future earnings to make vital purchases possible aligned with budgets and financial objectives.