Have you ever done business with a finance company or is yet to but find yourself wondering how they make their money? Well, you’re not alone in this as I’ve seen alot of people ask this same question. So I’ve decided to throw some light on this by answering the question of “how do finance companies make money?” in this article.
Majority of people depend on finance companies in order to make a huge purchase or solve a particular problem when they can’t pay upfront with their savings. But what exactly is a finance company and how do they make their money? Well, you’ll find out soon.
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What Is A Finance Company?
A finance company is a financial institution that is basically into the provision of loans to either individual borrowers or businesses. Unlike banks, finance companies do not offer services such as savings or checking accounts.
The loans they offer are usually backed by collateral in order to have something of value to rely on in case a borrower defaults. Additionally, the loans they offer comes at a cost in a form of finance charges which includes origination fee, interest rates, late fees, etc.
Finance companies are usually lenient when it comes to credit score requirements for a loan hence is usually the best option for persons with a not so good credit. That is why they try to guard against the risk of a borrower not paying back their loans by making sure that the item they are purchasing such as car or home is used as collateral.
How Finance Companies Make Money
Finance charges! That’s simple as that. Finance companies usually make money from finance charges which comes with your loan. Meaning that the higher the finance charge, the more money they make.
Interest is charged on the loan they offer you which ends up causing you to pay more than the principal amount you borrowed. In addition to the interest rate, other finance charges that comes with the loans offered by finance companies that helps them to make money include origination fee, late fees, APR and prepayment fees.
Although they are able to offer financing to customers with a bad credit, such customers are likely to be offered interest rates higher than one with a good credit score. Generally though, the interest rates offered by finance companies are higher than banks and credit unions.
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Finance Charges That Helps Finance Companies Make
Now let’s look at the individual finance charges that finance companies use to make.
- Origination Fee: this fee is charged by finance companies to process your loan application and it’s one of the ways they make their money.
- Late fees: this is a fee you’re charged if you make a late payment beyond the grace period.
- Interest rate: interest rate is basically how much your loan cost for a period and is expressed in percentage. The higher the percentage, the more money the finance company makes and that will mean your loan will cost more. Same way the lower the percentage, the less money they make and you end up paying less in interest.
- Annual Percentage Rates (APR): this is how much your loan will cost in a year and is also expressed in percentages. The higher the percentage the more money the finance company makes and vice versa.
- Prepayment Penalty: most finance companies usually charge prepayment penalty if a borrower decides to payoff his or her loan early.