Big Purchases: When to Save & When to Borrow
When you’re looking at a big-ticket purchase, one question always comes up: Should you pay with your savings or finance it? Or, if it’s a new home or car, how much of the purchase price should you pay up front, and how much should you borrow?
There is no simple answer. On the one hand, paying in cash can keep you out of debt. On the other hand, large cash purchases could wipe out much of your savings, while borrowing can help ensure you have more savings available for emergencies.
There are many factors to consider. Ask yourself these eight questions to figure out whether you should pay cash or use financing for your next big purchase.
1. What’s Your Timeline?
Do you need to make the purchase now, or can it wait? If your car is too old to fix or your refrigerator dies, you may need a replacement ASAP. Financing may be in order.
But if you’re working on building up your savings or improving your credit score, it may be worth postponing the purchase, especially for nonessential purchases like a new TV or pricey vacation. In the meantime, save your money in a High-Yield Savings account, Money Market account, or Certificate to grow your funds faster.
2. How Much Can You Afford to Spend or Borrow?
Create a monthly budget and subtract all your current expenses from your monthly income to see how much is left over. Using this information, you can determine whether you’d have enough cash available to take on a new loan payment or replenish money you pulled from your savings account.
If you can pay yourself back in a year or less, it’s probably safe to dip into your savings. If it takes longer, you may want to borrow to preserve your savings (unless you’ve been saving for a special purpose, like the down payment on a home, and will have plenty of savings left over).
3. Will Your Purchase Appreciate?
Sometimes, rising costs justify buying now and paying later, rather than delaying the purchase until you can pay in cash. For example, if you’re buying a home in a buyer’s market, taking on a larger mortgage now may help you command a lower price than if you were to wait. Because homes tend to appreciate over time (unlike cars or big-screen TVs), the increase in your equity may help defray the cost of the extra financing.
Another big purchase that can appreciate in value? A degree. That’s why so many students choose to finance much of their education. Yes, you’ll pay back those student loans with interest, but, ideally, an increase in earning power over time would make up for this.
4. Are There Fees or Penalties for Using Your Savings?
If you choose to use your savings for a purchase, make sure the funds are easily accessible. Outside of an emergency, you want to avoid incurring an early withdrawal penalty for pulling funds out of a CD or Certificate before it matures. The same goes for pulling some of your retirement savings out of a 401(k) or IRA early, which comes with an IRS penalty unless the funds are used for certain qualifying expenses. This can also set you back in the process of saving for retirement.
If you’ve set aside an emergency savings fund, this money should only be used for bona fide emergencies. As a reminder, experts recommend having at least three to six months’ living expenses on hand in case of an emergency.
5. Do You Get Any Down Payment Power?
A larger down payment may provide more favorable terms from a lender and negotiating power with a seller when buying a home or car. In addition, for a home, a down payment of 20% or more can save you the cost of private mortgage insurance (PMI), which can add thousands of dollars to the overall cost of your purchase.
6. Are There Any Added Benefits or Costs?
Making your purchase today, either by borrowing or paying in cash, can have hidden benefits or costs that should factor into your decision.
- A lower price for paying in cash
- A special low financing rate
- Credit card rewards points, rebates, or other incentives
- Related cost savings that come from making the purchase now (such as upgrading to a vehicle with better gas mileage or a more energy-efficient appliance)
If you decide to borrow to take advantage of a hidden benefit, make sure your interest payments don’t cancel out the benefits.
- Higher financing costs if you don’t have perfect credit
- Less cash available for other monthly expenses
- Difficulty paying back a loan or credit card balance (and an impact on your credit)
Before you buy, try to factor these hidden costs into the overall cost of the purchase, and into your monthly budget, to see whether financing or paying cash makes sense for you.
7. Will Your Credit Card Give You Special Benefits?
You want to avoid carrying a credit card balance whenever possible, but sometimes, charging a major purchase is a good option. A low-rate credit card can make financing affordable and practical, and credit card rewards can add extra perks to your purchase (provided you can pay off the balance right away). Also, credit cards may offer other benefits like extended warranties or price protection.
8. Is Financing Affordable?
Before you commit to using your savings or borrowing, contact your financial institution. They may be able to offer a low-cost financing option that fits your budget, so you can let your savings continue to grow.
If you’re facing a big purchase, whether planned or unplanned, talk to American Heritage. We make financing affordable with low-rate loans and credit cards for every goal.