What Does Financing Really Mean?
Jun 11, 2020 • 5 min read
Have you ever seen or heard the term financing and wondered what it means? As of late, lots of people are seeing changes in offers for cars, furniture, and more. Here is a simple breakdown of what it is and the essential information you should know before making a decision.
According to the dictionary: it is the act of obtaining or furnishing money or capital for a purchase or enterprise.
In other words, it is when financial institutions provide money or capital to businesses, investors, and consumers. Essentially, it provides an opportunity for people to make purchases they are unable to fund outright.
Two Types: Debt and Equity
Equity financing is when a company shares stock and receives money in return. This particular type of credit allows you to fund your business through investors. However, most people participate in debt financing!
Debt financing is largely associated with major purchases like cars, furniture and houses. If you choose to opt for debt financing, you must repay the funds you receive, and lenders will require you to pay a rate of interest. Unlike equity, debt financing, let's you maintain control of your business, investments, assets and more, which is something not guaranteed with equity financing.
When is Financing Used?
It occurs when money is received from a lender to fund businesses with money for working capital or capital expenditures. Ultimately, it’s used for purchases that you are not able to pay for in full at the time of purchase but will be able to pay off in the future. Most people use it for larger purchases or business fees, rather than minor spending.
Many people confuse financing with business loans from banks, however, the two have some very significant differences. Unlike a business loan, financing incorporates a wide array of loan products. Here are some examples:
Term loans (borrowing a specific amount of money that you must pay back within a fixed term at a fixed interest rate)
A business line of credit (usable for any potential business emergency, you can borrow up to a set amount and only have to pay back the amount you have withdrawn)
Merchant cash advance (a set lump sum payment, usually offered by a lender for a portion of a company’s future sales)
Is Financing a Good Idea?
Financing can be a good idea, as long as you know what you’re getting yourself into, are using it for a valid reason, and are able to meet the repayment requirements. When considering if financing is the right option for you, you should ask yourself some important questions:
What am I Using These Funds For?
Consider what you plan on using the opportunity to finance before diving into the process. You should ask yourself if it is worth the task of repayment.
What is the Amount of Financing I Need?
This question definitely bounces off the previous. You must ask yourself how much money you need. This will determine if you can truly afford it, taking into consideration the repayment process, interest rates, and your current funds. So the first step should always be to create a budget and get a sense of exactly how much you will require.
Do I Qualify?
There are different qualification standards depending on what you’re financing and where you intend on seeking it. Which lenders and loan products you qualify for will depend on a number of factors including your credit score and annual income.
Whether you can qualify depends on a variety of factors, one of which is typically your credit score. This is seen as an indicator of your ability to manage credit and whether the lender feels you are able to responsibly manage monthly payments. You can see where you stand for free through Borrowell, it takes 3 minutes and won't impact your credit.
What Is an Annual Percentage Rate (APR)?
You’ve probably seen (APR) when seeing a financing offer- this stands for annual percentage rate and refers to the annual rate of interest you pay to a lender. It is often shown as a percentage that clearly demonstrates the cost of funds over the term of a loan. It is designed to help borrowers understand the actual cost so you can compare rates with other institutions.
Regardless of whether you meet the qualifications for financing, it is important to consider both the advantages and disadvantages to truly know if it is the right choice for you and your personal finances.
The interest payments you pay are tax-deductible
Financing options provide a chance to build/improve your credit score
Once you’ve paid back your loan, your relationship with the lender ends
You can build your monthly payment plan into your budget to avoid shocking fees
Your interest payments are predictable
If you can’t pay back your loan, your financial health is put at risk
You need to make sure you make your payments on-time, otherwise, this could negatively impact your credit score
Adding debt repayment to your monthly budget can be intimidating and sometimes risky depending on if you have funds for emergencies as back up
The Bottom Line
Financing is an accessible opportunity for both businesses and individual consumers to meet the needs of their company and/or lifestyle. So long as you ask yourself the important questions before applying for financing, and educate yourself on all the necessary information, and whether it could be a good option for you.
Emily Norton is a Toronto based writer and editor. Her personal finance work focuses on themes of career building, lifestyle, wealth inequality, relationships, and budgeting. She is a staff writer for Money After Graduation Inc. and has also been feature on financial websites such as Greedy Rates and Wealth Rocket.