Your washing machine is 15 years old and the repairman has just left for the third time this year. It may be time to look at newer appliances. You have one of two choices: you can begin saving now while that washing machine is still running, or you can wait and finance the job when the time comes.
Your car is dead. It is time for a new one. You have a decent amount saved for a used vehicle, but then the salesperson tells you about a terrific deal on a new car. You don't have enough saved to pay cash - should you finance the newer model?
These are decisions we all have to make from time to time. Big expenses can take a big bite out of our savings, and when we don't have enough savings to cover the cost, financing may seem like our only option. But wait! There are a lot of things to consider before making that purchase.
The Bottom Line on Financing
The bottom line is that virtually every time you borrow money, you are paying more for the item than if you saved the cash to buy it outright. This can eat away at its value and even strip you of any value from a sale you may get if purchasing it right now. For instance, let's say that you are shopping for a new washer and dryer. Your current set still works, but you know their days are numbered. You see a set on sale at Lowes' for 15% off. Tempted to buy now and make installments until it is paid off? Sure, that washer and dryer may be on sale, but if you buy it using a credit card that charges the national average of 18-24% in interest, you are going to pay as much as 9% more for that appliance package than you would if you paid full price.
The fact is financing a purchase will cost you more. The amount it costs you will vary depending on the interest charged to you for the privilege of using credit.
Saving Costs Less
Now, let’s say that you save a little every month to buy that washer and dryer. By the time you have enough in your account to make the purchase, the price of the set you had your eye on has gone up 10%. Now you wonder if you should have bought the set earlier on credit. Let’s take a closer look. If you took one year to save the $900 to buy the washer and dryer that you wanted and you made about 1 % in interest from your savings account, you made roughly $9 from the bank by keeping your money in the bank. That amount will not cover the cost of the appliance increase. Wait! Don't forget, if you had financed those appliances, you would have paid between 18-34% interest over the last year. That means that even though those appliances would have only cost you $810 last year at the checkout, the total cost of those appliances over the last 12 months would have been between $944 and $982. That means by waiting until you had the cash to make the purchase, you saved between $44 and $82; even if you had to pay full price for the set. Now, factor in a sale, and you will save even more!
Sometimes Financing Does Work
That said, sometimes, financing does work in your favor - if you do it right. Let's look at our car example from above. You have $5,000 saved for a used car. You find one that is about 5-6 years old and has about 65,000 miles on it. The salesperson tells you about a 2-year warranty you can buy for another $1,300. You notice that the tires need to be replaced soon and fully expect that within the next five years, the car is going to need some costly repairs due to its age and condition. Since it is an older model, it only gets about 20 miles per gallon. Considering that you travel about 40 miles back and forth to work each day, that is a factor to consider.
Now, let's look at the newer model the salesperson showed you. Its sticker price is $15,000, which means that you will still owe $10,000 for the vehicle if you buy it. Since the car comes with a full six year, 60,000 mile bumper-to-bumper warranty and a ten year, 100,000 miles powertrain warranty, you don't need to buy additional coverage (saving you that extra fee of $1,300), plus you are free from any costly repairs for at least six years. Now the remaining cost is down to $8,700. To make the deal more appealing, you discover that you qualify for a 1.9% interest rate.
You begin to calculate the cost of gas (the newer model gets 28/37 miles per gallon which will save you money on gas) and projected maintenance and repairs. After factoring in all the pros and cons of the purchase, you decide that this is indeed one of those cases when it may be worth financing the purchase. First, you aren't spending that much more on the new car considering the gas savings, savings on future repairs, plus the fact that the new car will likely last 10 years or more. The used car will need replacement in five years or so. Therefore, you decide that yes, financing the new vehicle does make more financial sense.
When faced with this dilemma, be sure to pay off that new car as soon as you comfortably can. Then, if possible, take that monthly payment and put it in a separate savings account dedicated to large item purchases. That way, by the time you need to buy your next vehicle, you will have enough saved to pay cash for it.
It is true that saving for a big price tag item is always best. But don't be afraid to finance that purchase under the right circumstances. The key to making your investment work is to know all the facts so you can make informed and responsible decisions.