Basics of Financing

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You’ve heard it in a variety of places: “We offer financing.” So what does it mean to finance something, and what do you need to know before accepting these offers?

What is Financing?

In general terms, financing is the act of providing funds to somebody else. When a business offers financing, it means they’ll lend you money. You don’t need to pay 100% of the purchase price up front, all at once. Instead, you can pay over time, often with monthly payments.

In some (but not all) situations, you’ll have to make an initial down payment to get things started.

That might sound great, but financing is rarely free. You’ll almost always pay interest on the amount you “borrow” (even though it doesn’t feel like you borrowed – instead of getting cash in hand, you’ll get your goods or services for little or no payment). Those interest costs effectively raise the price of whatever you buy. You might have to pay additional fees related to the loan as well.

Financing can be used for pretty much anything, but it’s especially common for expensive things – after all, if it was inexpensive you’d just pay cash. Some common examples include:

  • New and used automobiles (including RVs, motorcycles, and others)
  • Home and property purchases
  • Appliances and electronics
  • Rent-to-own furniture and appliances (yes, you’re basically borrowing – but things are a little different with a rent-to-own home purchase)
  • Services (plumbing or dental work, for example)

How to Borrow Wisely

Financing is a tool, and it can help or hurt you depending on how you use it (and depending, to some degree, on luck). If you can avoid borrowing altogether, that’s always the safest bet. But if you must borrow, stick to buying things with the following characteristics:

  • You can’t afford 100% of the purchase price
  • You’re paying for something you need (not want)
  • You’re paying for something that will last at least as long as your required monthly payments
  • You’ve researched and are getting the best purchase price (not just a tolerable monthly payment)
  • You can easily afford the required payments (calculate your payments and limit them to a small portion of your monthly income)

Of course, once you borrow it’s essential to make payments on time. Any late payments will hurt your credit scores, and your lender might take more severe action if you eventually default.

Before you Sign on the Dotted Line

If financing seems like a wise move, a bit of research before you sign off on the deal can help you save money and avoid mistakes.

Check your credit: anytime you borrow – especially for a major purchase – you want to know that your credit is in good shape. If you haven’t reviewed your credit reports lately, do it now (it’s free). Information in those reports can result in getting a higher or lower rate, or even denial of your application. Fix any errors, and continue to pay bills on time so your credit continues to improve.

Shop around: you don’t have to borrow from the first company that offers financing, and you don’t even have to borrow from the store or dealership you’re buying from.

One-stop-shopping might be more convenient, but it might also be more expensive. However, there are times when your best deal comes with the item you’re buying (such as 0% financing at an auto dealer, plus you can set everything up over the weekend while banks are closed). Just to be safe, compare loan terms from a few other banks, credit unions, and online lenders.

Understand the costs: when you want something badly, it’s easy to overlook how much you’re paying – especially if it seems inexpensive because of affordable monthly payments. But financing is rarely free. Read through disclosures to figure out how much you’re really paying, and evaluate if you’re making the best choice.

Watch for bait-and-switch: some companies advertise over mass media, highlighting their most attractive offers.

However, you might not qualify for those deals. Ask what it takes to get the best financing, and review paperwork before you sign it to ensure that you’re really getting what you think you’re getting. In many cases, you need excellent credit to qualify for advertised specials.

Know the consequences: the payments might be affordable now, but what if you stop making payments (perhaps due to an unexpected change in employment)? With many items, the seller or lender has the right to take your collateral back and sell it. For example, if you stop making car payments, the lender will repossess your vehicle. If you default on your home loan, you can be forced out due to foreclosure. With almost any loan, missing payments means you’ll damage your credit – and it’ll be harder to get financing in the future.

Who Provides the Money?

When you apply for financing, you might wonder who the lender is. In many cases, it’s a bank or credit union that has a relationship with sellers. Sometimes it’s a finance company that arranges funding (but doesn’t have branches and offer other standard banking services). Although it’s not as common as you might think, sometimes the same person or company that sells you an item does the lending. For example, buy-here-pay-here auto lots manage their own loans, and some homes are sold with owner financing.