Long-Term External Financing: Understanding Mortgages in Business
Written on
Chapter 1: The Nature of External Financing
External financing refers to funds sourced from outside a business. Mortgages fall into this category. When companies require funds for an extended period (typically exceeding five years), they often look to long-term financing solutions.
The financial requirements for acquiring Fixed Assets, or Non-Current Assets, can vary significantly. For instance, purchasing low-value items like vehicles may necessitate a smaller amount of long-term financing. Conversely, acquiring high-value assets, such as new machinery for production lines, demands a much larger financial commitment.
Section 1.1: What is a Mortgage?
A mortgage is a specific type of long-term loan from a financial institution, designated for purchasing real estate, including land or buildings.
Mortgages share similarities with long-term bank loans; however, while the latter can be utilized for various purposes such as business expansion or equipment acquisition, mortgages are strictly for real estate transactions.
The borrower is responsible for paying interest on the borrowed amount, which is typically repaid in installments over a set duration—often 10, 20, or 30 years.
Subsection 1.1.1: Advantages of Mortgages
Mortgages can enhance the flexibility of a business's limited capital by enabling investment across multiple projects. This means a business does not need to allocate all its funds to one Fixed Asset, which can lead to cash shortages for other initiatives. Consequently, this approach can help alleviate pressure on operational cash flow.
Section 1.2: Risks Involved with Mortgages
At the conclusion of the mortgage period, the total borrowed amount must be repaid to the lender. Failure to meet payment obligations (defaulting on the loan) can result in the lender seizing the property without any compensation to the borrower. Essentially, the mortgage grants the lender the authority to sell the property to recoup the loan if payments are not upheld as agreed.
Chapter 2: The Drawbacks of Mortgages
The first video, "Edmentum Financial Math Unit5 Activity - YouTube," explores the complexities of financial math in relation to mortgages, highlighting critical concepts and calculations that businesses should understand.
The second video, "201720 Excel Guided Project 4-3 - YouTube," demonstrates how to utilize Excel for financial projects, including mortgage calculations, providing practical insights for effective financial management.
One significant disadvantage of mortgages is the extensive paperwork involved. Engaging in a real estate purchase is already complex, but acquiring a property through a mortgage adds additional layers of procedures and documentation.
In summary, mortgages are secured loans specifically designed for purchasing real estate, such as land and buildings, providing both opportunities and challenges for businesses seeking long-term financing.