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Making a large purchase is an important decision that can affect your finances in the long run. Therefore, it is always wise to take your time and weigh your options before deciding. Another essential aspect of a large purchase is funding. You must decide whether you will pay for the purchase from your own pocket or you need to avail of a loan.
One way to fund a large purchase is to plan a few months in advance, save some money, and avoid debt as much as possible. However, in some cases, planning in advance is impossible. For example, to replace a vehicle or appliance that has broken down. There is no one size fits all policy for financing a big purchase. Every approach has pros and cons, and you must answer the cash vs. credit question as per your financial situation.
Reasons to Save Money
There are many benefits of financing a big purchase by dipping into your savings. You can wait and make the purchase when you have enough cash-in-hand, instead of increasing your debt burden. Here are some reasons why it may be wise to save up for the big purchase –
- If you save and pay cash for a big-ticket purchase, you can negotiate a better price and get a discount by paying cash upfront.
- As you work towards building your savings, the money in your savings account will accumulate interest. Even though interest rates on savings accounts are low, it would be better than paying interest on a loan.
- Suppose you save enough for the down payment on a car or a house. In that case, it enables you to complete the purchase with a smaller loan and reduces your overall cost of borrowing.
Reasons to Borrow Money
Sometimes it is wise to go into debt to fund an essential purchase for your home or family. One of the most common reasons is urgency. A loan may be the best solution if you don’t have sufficient savings and need to purchase something urgently. Here are some benefits of taking out a loan to fund your purchase –
- With a pending price increase or a unique sales opportunity, you can avail of a loan to complete the purchase at the right time.
- When purchasing something that will likely appreciate in value, such as real estate or gold, it makes sense to go into debt.
- If your savings are locked in a long-term investment scheme such as mutual funds or a retirement plan. Redeeming your investment, fully or partially, may play havoc with your long-term gains. In such cases, it is best to go for a loan.
Reasons to Save Money Over Borrowing
Even though it is wise to go into debt in some situations, on the whole, debt is best avoided. Or at least strive to reduce your debt burden instead of increasing it. Here are some significant advantages of saving money instead of borrowing:
- Cut Down Your Debt Burden
The primary reason to save money is to have small financial support to fall back on whenever the need arises. Instead of buying an expensive item by taking a loan, you can avoid debt and fund your purchase by withdrawing your savings. All you need is some patience until the amount accumulates.
- Reduce the Expense of Interest
If you avail of a loan or buy a big-ticket item using a credit card, you will have to pay the amount back with interest. In the end, the item costs higher than the quoted price. On the other hand, if you buy using your savings, you may get the item cheaper than debt.
- Pay Cash in Full for a Discount
All big-ticket items such as refrigerators, washing machines, and sometimes even cars offer a discount for paying the entire amount upfront. If you take a loan to purchase the item, you cannot pay the entire amount upfront. And therefore, you will forego the discount available to cash-payers.
- Negotiation Power
Saving money and paying upfront for a non-emergency or luxury item gives you to power to negotiate for a better price. Cash upfront is a known method for getting the discount you need. However, if you choose to pay in instalments, you may never get a discount from your seller.
- Avoid the Debt Trap
There are many different types of savings accounts to choose from. The interest they offer may not be substantial. Still, savings accounts are a modestly better option to fund your significant purchase. Opening a savings account and patiently waiting for your savings to grow keeps you in a safe place and helps you avoid the debt trap.
When deciding between savings vs. borrowing to fund a large purchase, start by asking yourself how urgently you need the item. If it is not urgent, saving and making the purchase is best after you have accumulated enough money. If it is an emergency, stop and analyze your options and choose an option that does not increase your debt burden more than you can manage.
