The High Cost of Installment Sales
The ability to purchase $5,000 or more in home furnishings with no cash out of pocket is too irresistible for many Americans, and companies are fully aware of this. The installment sale is a tool they use to boost revenues by selling to people who otherwise can’t afford to purchase their products. The problems with installment sales include the following:
• The limited up-front cash commitment and low monthly payment entice customers to buy more than they can afford. If buying on installment becomes habitual, it most often leads to crushing levels of consumer debt with dire consequences for the family.
• Many financing plans carry interest rates of 20 percent or more. While no payment may be required for six months, in many cases interest begins accruing immediately substantially increasing the cost of the purchase.
• With an installment sale, there is a presumption that you’ll be able to meet the required future monthly obligations. Proverbs 22:26–27 reminds us, “Be not one of those who give pledges, who become surety for debts. If you have nothing with which to pay, why should your bed be taken from under you?”
• In many cases, companies offering installment sales actually have higher prices than other companies because they have to cover losses associated with delinquent accounts. In addition to owing 20 percent interest, you may be paying substantially more for the item to begin with. One example comes to mind: A well-known retailer offered a set of cookware for $69.97 with payment in full at the time of sale, while another retailer offered the same cookware at $129.99. While few people paid cash up front to purchase the cookware from the second company, many were enticed to use the payment plan of 18 installments at $11.49 each. If they had done the math, they would have realized that they were paying $206.82 for what they could have had for $69.97 at the first retailer.
So avoid the temptation of buying something you can’t afford through an installment sale. Instead, save up so you can pay cash for the item. Who knows after saving the money, you may realize that you really didn’t want it anyway!
What about Automobile Loans?
After housing, transportation is frequently the second highest expense in a budget. You can go a long way toward reducing your transportation costs by being smart about how you pay for a car. Remember my rule of thumb for taking on debt: You should only go into debt for an appreciating asset. Does a new car appreciate when you drive it off of the dealer’s lot? Absolutely not! It depreciates 15 percent immediately since it’s no longer new, and another 20 percent or so every year.
Consider purchasing slightly used cars with low mileage rather than buying them new. You avoid the 15 percent premium you would have to pay for a new car, and that adds up with today’s car prices. Second, learn to save ahead for major purchases such as a vehicle so you can pay cash. Why pay the banks all that interest? By the way, car companies love to lease you the vehicles. They know they make more money in the long run, since you’re replacing the car fairly frequently. Pay cash for your car, keep it maintained, and drive it until either the cost or hassle of repairs isn’t worth it any longer. Then sell it and pay cash for your next used car.
With that said, there may be times when financing a car makes sense. A good example is when an automobile manufacturer has a glut of inventory and develops incentive programs to reduce inventory levels. They may subsidize the purchase of a car by offering one percent financing for three years. Assuming that you’ve already shopped around and the price is a good value relative to the cost of a slightly used car, the financing program can be an added benefit. In cases such as this it can make sense to leave the money in the bank, where it will be earning more interest than you’re paying the finance company.
Co-signing: The Risks May Surprise You
The Book of Proverbs provides great insight into the issue of surety and co-signing. The basic principle is to not go there! Proverbs 6:1–5 says:
My son, if you have become surety for your neighbor, have given your pledge for a stranger; if you are snared in the utterance of your lips, caught in the words of your mouth; then do this, my son, and save yourself, for you have come into your neighbor’s power: go, hasten, and importune your neighbor. Give your eyes no sleep, and your eyelids no slumber; save yourself like a gazelle from the hunter, like a bird from the hand of the fowler.
This verse doesn’t suggest that there’s anything morally wrong with co-signing, it just provides ample warning that the co-signer has to be aware that he or she has full responsibility for the debt.
If you’ve been asked to co-sign a loan, ask yourself why the bank won’t lend the money without your participation. Chances are the borrower is young and trying to establish credit, or the bank has reason to believe that the borrower is in over his or her head.
If you’re still considering co-signing, you’ll want to think through the following issues. When you co-sign, be aware that the debt will be listed on your credit report, and in the event that the primary signer is late with payments, that information would be indicated on your report as well as his. There are cases in which you may be taking on a greater responsibility than you think. For example, if a college student were to ask his parents to co-sign on a credit card, the bank may be able to increase the credit limit without notice to the co-signer. That could be a recipe for disaster. Finally, if the primary signer fails to meet his obligation, the finance company will come to you for the balance, and you’ll be bound to pay it.
Phil Lenahan is Director of Finance at Catholic Answers and author of Catholic Answers’ Guide to Family Finances. If you have a question you would like Phil to address, contact him at plenahan@catholic.com.