Finance


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Finance simply means obtaining funds or capital.  There is consumer finance which is credit in the form of loans.  This includes mortgages, secured and unsecured (personal) loans and credit cards.  This form of finance usually funds consumption, hence the name consumer finance.  This is sometimes known as 'bad debt'.

Business, or commercial finance is credit that is taken for the purpose of investing in some productive activity.  The debtor hopes they can make a profit on the finance taken by producing something of value.  This is sometimes known as 'good debt'.

We recommend that personal consumer debt is kept to a minimum.  The simple reason for this is that whenever you spend borrowed money, you have to pay it back with interest!  When you spend your own money, you don't have to pay interest on it.

Let's have a brief look at the main different types of finance:

Consumer Finance

Mortgages

A mortgage is the standard method by which individuals and businesses can purchase property without the need to pay the full value immediately from their own resources and a residential mortgage is most people's biggest liability and financial commitment.

A mortgage is simply a loan made by a lender to a borrower that is secured against the property that the borrower wants to purchase.  That means that if the borrower defaults on the mortgage payments, the borrower can take the property as collateral (security).

A deposit on the property is usually required by the lender and the amount of deposit usually depends on a number of factors such as the general availability of credit in the money markets, the type of property and the credit rating of the borrower.

The interest rate (APR) that the lender charges on the loan is also affected by the factors above as well as the central bank base rate of interest.  The central bank in the U.K. is the Bank of England (BoE).

The borrower can usually choose a repayment mortgage (capital and interest) or an interest-only mortgage.  The borrower can also choose between a variable rate of interest (e.g. a tracker mortgage) or a fixed rate mortgage, where the interest is fixed for a certain period of time, usually 2 - 5 years.

>>> Learn more about different mortgage options
>>> Mortgage and remortgage advice
>>> Speak with one of our independent mortgage advisers

Secured Loans

A secured loan is a loan in which the borrower pledges some asset (usually a property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan.  A mortgage is the most common form of secured loan but secured loans nowadays have become synonymous with a further charge against a person's property.

The three most common reasons for a person applying for a secured loan are 'home improvements', funding for a business and debt consolidation.  A homeowner who takes a secured loan is effectively releasing equity from their home.

Secured loans are useful for people with equity on one or more properties and who may be prevented from taking a personal loan due to a poor credit score.  Unsecured loans can also be larger and spread over a longer periods of time than personal loans (see below).

The interest (APR) rate on secured loans may be fixed for a period of time, but will usually revert to variable rates especially if the loan is over a longer period of time e.g. over 5 years.

>>> Find a secured loan
>>> Release equity from your home
>>> Speak with one of our independent financial advisers

Unsecured Loans (Personal Loans)

An unsecured or personal loan is a loan that is not backed by security and is based solely upon the borrower's credit rating.  From a lenders perspective, an unsecured loan is riskier than a secured loan because it is not backed by anything, other than the borrowers promise to pay and this is why a persons credit rating is given so much importance by the lender.

People take out personal loans for the same reasons as secured loans and they are particularly useful for people who are not home owners, or who have little equity in their property but who have good or fair credit ratings.

The interest (APR) rate on unsecured loans is usually fixed for the life of the loan so budgeting for monthly repayments is easier.

>>> Get help to reclaim PPI (payment protection insurance)
>>> Get a personal loan

Credit Cards

A credit card is basically another form of unsecured borrowing where the issuer of the card grants a line of credit to the consumer from which the user can borrow money for payment to a merchant or as a cash advance to the user.  The amount of credit someone is granted on a credit card (called credit limit) is related to their credit rating, as with a personal loan.

Credit card issuers usually waive interest charges if the balance is paid in full each month, but will typically charge full interest on the entire outstanding balance from the date of each purchase if the total balance is not paid.  Credit card interest is usually the highest rate of interest (APR) you will pay on any debt, usually in excess of 15% and well over 20% for regular defaulters.

The main benefit of a credit card to a customer is convenience, eliminating the need to carry a lot of cash.  This is especially useful when travelling in foreign countries, as most of them now accept major credit cards.  Credit cards also offer more fraud protection than debit cards for example.

The disadvantages of a credit card to a customer is the high interest rates, late payment charges and the risk of having their credit rating affected if they make late payments.

>>> Get the best rate on a new credit card
>>> Find out how deal with credit card debt
>>> Could you be entitled to claim credit card compensation?

Business (Commercial) Finance

Finance for business can take many forms, which include:

Start-up Finance: usually in the form of a personal unsecured loan, or a secured loan made by one or more directors.

Business Loan: usually made to a business that has a good trading history, by a bank.  This will usually be an unsecured term loan.

Asset Finance: a secured loan made to a business by a bank, that is  backed by company assets (such as property or machinery).

Venture Capital: private capital that is lent to a business, usually for an equity share in the company.

Company Shares: if the company is private, shares can be made available to private investors for an equity share in the company (in a similar way to venture capital).  If the company is public, then this process is carried out through a stock market.

Bonds: a company can borrow money from private investors by issuing bonds.  This commits them to pay back the original amount borrowed plus interest at a set future date, or date intervals.

As with any lending, any individual or organisation that wants to lend money will look at two factors: possible rate of return and risk.  Start-up ventures are often the riskiest to lend to as they have no trading history and are usually backed only by people and a business plan.

Larger companies with a strong trading record are usually likely to secure larger quantities of cheaper finance due to the fact that lenders feel less risk.  Even though it can be argued that new companies with tight budgets need cheap finance more than larger companies, from a lenders point of view, if they are going to take more risk they want to earn a better rate of return on their capital (interest rate).  This is the same with personal finance.  Think about mortgage and loan rates - people with poor credit credit histories will pay higher interest rates than people with better credit histories!

>>> Find out more about commercial finance & business loans
>>> Find venture capitalists and business angels

 

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