Most people have been taught that debt is bad. In most cases, they're probably right. But it also depends on what the debt is for, and what you actually consider to be debt. When you go into debt, you're spending money you don't have yet. There's no collateral for that money, and you're relying on your future income to make sure you pay it back. But if you're buying a big-ticket purchase, you have something for your money. Here's how to decide which of the options is going to be the right one for your needs.
Let's say that there's a car you want to buy and it costs $30,000. There are two ways you can pay for the car:
- Pull $30,000 out of your savings account
- Finance the car and make payments on it
If the interest rate on the savings account and the interest rate on the financing agreement are equal to one another, you're not going to pay more money with one option than you will with the other. The actual costs are the same, barring any additional caveats or issues that could affect the transaction.
A 5% interest rate would have you paying $30,501 for the car if you financed it, and $30,501 (the $30,000 you pulled from savings plus the money you would have earned on that amount) if you pay cash. However, there's more to the equation than just the actual amount you're paying. You also have to consider which of those options would put you in an advantageous financial situation. To keep the advantage, you need to keep control, and that's best done by helping your money work for you.
Pay Cash or Finance
Consider this scenario carefully, because the control you have over your money isn't the same in these situations.
If you buy the car, you drain your savings account. Yes, you have a $30,000 car in the driveway, but you also don't have the money you've saved up and stored away. You can't use that money for anything else, because you spent it to buy that shiny new vehicle. It may be a really great car, but it's not something you can take to the bank and spend on something else you might need. (Related Reading: Consider All Costs Before You Buy)
But, if you finance the car, you still have $30,000 in savings. You have access to that money, and you can use it for something or allow it to keep earning interest. You don't have to worry if you get an unexpected bill, since you have the money to cover it, and that can really help you have peace of mind. In the meantime, though, you still have a $30,000 car in your driveway. So you have the money, access to the money for other things, and a lovely new car in your driveway, that you can use and enjoy.
The difference between the first scenario, where you have the car but no cash, and the second scenario, where you have the cash, the use of that cash, and the car, is a difference of control. If you want control over your money, and you want to leverage the cash you have for as many needed and/or investment-based purchases as possible, you want to use the power of careful financing. That can help you develop and build your wealth over time.
Conclusion
Focus on the details of the transaction and the control of the money you have. That helps you to make a better decision when it comes to whether you want to pay cash for a big purchase or finance it instead. Sometimes, paying cash is the clear winner. But much of the time, financing a large purchase and keeping access to the cash you've saved up is the safer choice to keep financial control. When done correctly, financing can help you leverage what you already have to your biggest advantage.
Learn more about the strategic use of financing in our program, Financial Foundations. This complimentary 8-week course is available to you at no cost because we believe this information should be available to everyone, regardless of circumstance. Register for the next course or read more about it on the Financial Foundations webpage.