How to pay for a significant purchase is dependent on a number of either/or decisions. Credit or cash? Do you want to borrow or save? Earlier or later? To prevent debt, many individuals think they should save money before making a purchase. Unfortunately, according to experts, there isn’t a simple, universal solution to the cash vs. credit debate.
Saving money to purchase a large-screen television or washing machine frequently makes sense since you avoid incurring interest by not taking on loan, which raises the final cost of the item. But what if your existing washing machine simply broke down and you need one right away? What if the washing machine’s price has increased after a year of saving more than the interest you would have had to pay to charge it? What if the washing machine is on sale and the retailer is providing a 12-month period of 0% interest and no down payment?
Motives for Paying Cash
People may have to put off buying something until they can pay for it altogether because their financial circumstances prevents them from taking on further debt. Even yet, it could be wiser to wait to make a large purchase until you have the cash on hand.
It may be feasible to negotiate a lower price for a non-emergency big-ticket item by saving up and paying cash. A tried-and-true negotiating tactic with a lengthy history is “cash upfront.” Although interest rates on savings accounts aren’t very appealing right now, any return is better than interest going out, so saving is at least somewhat superior than taking on debt. Additionally, saving for a down payment (or a larger down payment) on major purchases like a vehicle or a home enables you to get a smaller loan and lower your total borrowing costs.
Motives for Borrowing
Of course, there are situations when taking on debt makes sense. The above-mentioned factor of urgency is one of the most frequent ones. The moment an appliance breaks, you need a replacement. Therefore, taking out loan can be your best alternative if you don’t have enough cash to purchase it altogether.
Even when it’s not an urgent requirement, a looming price hike or particular sales opportunity might influence your choice to charge the item. Make sure the savings from this financed item still outweigh the savings you would experience by waiting until you could pay cash once interest is taken into account.
It may make sense to buy today and incur debt when making a purchase that will probably increase in value. Examples include financing a college education or purchasing a home. The same rules would apply if you choose to borrow money as opposed to taking it out of your savings, investments, or retirement account. In certain circumstances, borrowing is often a wiser choice due to the possible long-term profits on investments or savings, as well as the potential harm to a retirement account.
Buying in advance may be preferable when interest rates are at an all-time low.
This is particularly true if you believe interest rates may increase significantly before you have enough money saved to complete the purchase. Just be aware that the annual percentage rate of interest, if it’s a credit card you’re using, is probably in the double digits, so it’s not exactly cheap.
The Charge-It-and-Pay-It-Off Strategy
The finest of both worlds may be had in one simple approach. That occurs when you use a credit card to make a large purchase and then pay it off right away or within a certain promotional interest time frame. Rewards might be given to you in the form of added airline miles, points, or even cash back. You might still avoid paying interest by using them as an extra discount.
Extended product warranties, travel insurance, and other consumer protection features are often included with credit cards. You get the advantages for nothing if you charge the purchase and promptly pay it off.
When Credit Turns Into Smothering Debt
Avoid maxing out credit cards or other accounts. Any savings might be soon lost due to late penalties, overlimit fees, and other expenses. Avoid making the mistake of abandoning your strategy to pay off a significant charge in order to make another sizable buy. This is how easy access to credit can lead to crushing debt very rapidly.
Make sure you have enough money in your bank account to pay off the debt before the end of the month or the end of the period during which there is 0% interest. Avoid billing the purchase if that isn’t possible.
Start by asking yourself how fast you need the item before determining whether to borrow it or save for it. Saving up is often the wisest course of action if it’s not an emergency. If there is an emergency, go through your borrowing alternatives and choose the cheapest one. If there is no urgency but you have decided that purchasing in advance makes sense for one of the factors discussed in this article, verify your reasoning again to be sure it is accurate before moving on.
Finally, particularly when thinking about taking on debt, make sure you have a strategy in place for repaying that debt in the event that anything unexpected occurs, such a decrease in take-home income or losing your job.