After glancing at the topic of this post, you might be thinking, “Financing is never frugal!” And in a way, you’d be right. Because financing comes with interest, which is going to make your final cost more expensive than the original price.
But you know what really isn’t frugal? Credit card debt. The current average interest rate for a 30-year fixed mortgage is just over 4 percent, which certainly beats out that current average interest rate on a credit card, which is almost 15 percent. In other words, some loans are a better deal than others.
The reality is, most of us aren’t walking around with savings or checking accounts filled with six figures, and so we finance select purchases so that we can afford the things we need, like shelter and higher education, without charging it all on credit cards with astronomical interest. When used properly, financing can serve as a tool to help us better leverage our cash flow.
The trouble with financing, however, is that it has become overused. Not only do we buy things with it that we can’t afford at the moment, but we buy things that we can’t afford, period. Not only that, but we’re using financing to purchase things that inherently depreciate in value like cars and furniture, rather than reserving financing for things like homes and education that at least have the potential to provide a return on investment.
So why do people continue to finance things they know they can’t really afford and that instantly lose value the moment they walk out the door? Here are a few reasons, which I hope will make it easier for you to decide when to skip the purchase, and financing, altogether.
Emotions: Spending is an emotional process. Unfortunately, those emotions have a tendency to sway us in favor of less than rational choices when it comes to our money. Just take a look at the diamond industry. If you’ve ever tried to sell an old engagement ring, for example, you’re likely familiar with how incredibly little value diamonds have on the secondary market. You’re lucky if you get 50 percent of what you paid for it.
Diamonds are a lousy investment with a ridiculous retail mark up. Add financing on top of that and there’s no rational reason to buy a diamond ring unless you have the cash on hand to afford it, except perhaps sentimental value and societal pressure. And considering that money issues are one of the leading causes of divorce, financing the ring and adding to debt or an already tight budget might cost you your marriage altogether. The bottom line: Skip the ring and save the relationship.
“Free” financing: The other reason people finance when they shouldn’t is because they get suckered into interest-free financing promotions. While a period of six to 12 months of zero interest sounds like a good deal, there’s a major catch. If you miss one payment or don’t pay off the entire balance during the promotional period, then you’ll not only get charged high interest from that point on, but you’ll often be charged interest retroactively from the date of purchase. Not a good deal.
So while interest-free financing can work in your favor if you’re able to make all payments on time and in full before the end of the promotional period, it becomes a total gamble when you’re not positive you’ll have the cash to pay it all off in time.
Immediate gratification: If you implement the same strategy of interest-free financing in reverse by making progressive payments towards a purchase in advance, it would be called savings, and there would be no financial risk or consequence if you fell short. Unfortunately, there seems to be a growing tendency to purchase an object first and then work toward paying it off, rather than looking ahead and saving for the next year to buy the object without the gamble.
The fact is, if you can’t keep up with the savings contributions required to afford something, then you probably won’t be able to keep up with the payments required to pay it off, leaving you stuck with horribly high interest rates that could have easily been avoided.
So the next time you’re tempted by a seemingly sweet financing deal you saw on TV or in store, give yourself some time away from the pressure of the pushy salesman or the sentimental nature of the advertisement and take the time to clearly assess the value of what you’re buying without the overwhelming emotional influences. When you’re able to approach financing from a strictly rational and value-based point of view, you’re more likely to make the frugal choice.
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Frugal Alternatives to Traditional Financing originally appeared on usnews.com
