The proverbial question people always ask of financial advisor is: “Should I save up for a large purchase or finance it?” More often then not, this question is a want versus need issue. So, in most cases, the answer is simple. If you “need it” and don’t have the capital, it may be all right to finance it. If it is a “want it”, save for it and make sure it is not taking the place of acquiring a need. Of course, that is more often then not a mechanical response, all things being equal and we know in life, that is seldom the case.
The actual question of saving money for a large purchase is really tied to a series of either or choices and is not linear. Cash or credit? Save or borrow? Now or later? Many people believe they should save up before buying to avoid debt. Surprisingly, experts say there is no easy, “one size fits all” answer to the cash versus credit question.
Saving Money versus Debt
Saving up to buy a big-screen television or washing machine often makes sense, because by not going into debt you avoid interest that adds to the price. But what if you need that washing machine right away because your current one just broke down? What if after a year of saving the washing machine has gone up in price more than the interest you would have paid to charge it? What if the washing machine is on sale for no money down and zero interest for 12 months?
“Too many people spend money they haven't earned, to buy things they don't want, to impress people that they don't like.” Will Rogers
Reasons to Save
Saving up and paying cash may make it possible to negotiate a better price for a non-emergency big ticket item. “Cash up front” is a tried and true bargaining tool with a long history. Although savings account interest rates are not optimum (especially today), any interest coming in is better than interest going out, making saving at least modestly preferable to going into debt. Saving for a down payment on a car or house allows you to use that down payment to reduce the overall cost of borrowing.
Sometimes people are forced to save because their financial situation won’t allow them to take on more debt. It may be better to put off that large purchase until you have the money in hand.
Reasons to Borrow
There are, of course, times when it makes sense to go into debt. One of the most common reasons, mentioned above, is urgency. If an appliance fails, you need a replacement, and if you don’t have sufficient savings to buy it outright, debt may be your best option.
A pending price increase or special sales opportunity – even when it’s something that isn’t an emergency need – could also push you into a decision to use credit for the item. A word of caution thought is make sure it is a real savings opportunity. Retailers and car dealerships use coy marketing techniques to make it seem like today is always to best day to buy. Do your research and decide whether it is a true deal or a sales tactic. Boxing Bay and Black Friday come to mind. Finally, it’s important to make sure that the savings, even with interest, is more than the savings you would realize by paying cash
When a purchase represents something that will likely appreciate in value, buying now and going into debt might make sense. Examples would include paying for college or buying a home. The same would apply if you decided to borrow instead of taking from investments, savings, or a retirement savings account. In those cases, long-term gains on investment or savings, not to mention the potential damage to a retirement savings account, often make borrowing a better option.
The current climate of extremely low interest rates may also make buying on time a better choice. This is especially true if you feel interest rates might take a significant hike before you can save up enough to make the purchase. Just be aware that if it's a credit card you're using, those interest rates still aren't all that low and are exceedingly higher then waiting and using alternative credit at a much rate of interest.
“Credit is a system whereby a person who can't pay, gets another person who can't pay, to guarantee that he can pay.” Charles Dickens
Charge It Now and Pay It Off
There is one way to have the best of both worlds. That’s when you charge a large purchase on a credit card, then pay it off immediately or within a specified zero interest time range. You may get rewards, in the form of bonus airline miles or points or even cash back. These could represent an additional discount, and you would still avoid paying interest. Credit cards typically feature extended product warranties, travel insurance or other consumer protection benefits. If you charge and immediately pay off the charge, you get the benefits for free. Be careful of some interest-free offers. In general, deferred interest promotions are a trap and the “savings” is just reflected in the established sales price or administrative fee.
Credit Caveats
It’s important not to max out credit cards or accounts. Late fees, over limit fees and other costs can quickly wipe out the advantage of any savings. Don’t fall into the trap of failing to honour your plan to pay off a large charge because you want to accommodate another big purchase.
“Some debts are fun when you are acquiring them, but none are fun when you set about retiring them.” Ogden Nash
This is how access to credit can quickly become suffocating debt. Make sure you have enough in the bank to pay off the balance by the end of the month or zero interest period. That’s where retailers, credit card companies, and lenders hope to snare you. They prey on those they know cannot, and will not pay, off their balance in time. They make money on the high interest rates they charge you. These credit facilities are easy for the vulnerable to obtain and difficult to exist. If you can’t do this, avoid charging the purchase.
The Bottom Line
As I already mentioned in the beginning, when deciding whether to save or borrow, the first question is to start by asking yourself how quickly you need the item. If it’s not an emergency, saving up is often the best option. If it is an emergency, review your borrowing options and choose the one that costs the least. If it’s not an emergency, but you’ve concluded that buying on time makes sense for one of the reasons described above, double check to make sure you are right before proceeding. Finally, especially when contemplating going into debt, make sure you have a plan for paying off that debt if the unforeseen happens, such as a cut in take-home pay or losing your job. Having a plan is prudent, helps avoid being caught in the credit crunch and goes a long way to Keeping Life Current.
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