Everyone knows that you have to save money – but many people just don’t do it because they don’t have a budget. Today I’m going to illustrate the financial advantage you have by saving for major purchases versus financing them (via credit cards, lines of credit, etc.).
Let’s assume that we have a $5,000 major purchase coming up – perhaps a new deck for the house? And let’s assume that our buyer is making the purchase at one of those big-box type stores (which conveniently offer a department store card). If he/she were to put the purchase on their credit card they could pay off the purchase of the deck over 2 years by paying $252.56 per month (assuming a 20% interest rate on their credit card).
If the buyer were to save-up for the purchase they could use a high-interest savings account (currently paying about 4.25%). Let’s compare apples to apples: if they were to save $252/month to this savings account, after 2 years they would have $6,318 to spend on this deck (so they could have a bigger deck, or a better deck). Alternatively, if they only wanted to spend $5,000 – they could save less per month. In this case $200/month would give them $5,014 after 2 years. And the final option would be to save $252/month for less than 2 years to arrive at $5,000 (which would take 19 months – just over a year and a half).
I think to make the point I want, I have to look at the last option – to save up for a $5,000 purchase would cost you (19 months x $252) = $4,788. To finance it would cost you $6,048 ($252/month x 12 months). That’s more than a 20% difference in what you are paying out of pocket.
Let’s look at another example: How about a vehicle? Let’s look at a $30,000 car. If you wait for a reasonably good deal, perhaps you get a finance rate of 4% over 7 years. That works out to $468.91/month. Again, let’s try to be as “apples to apples” as we can and assume that $468.91/month is the amount that we have to work with. So if we put that into a high interest savings account we will have $30,000 saved after 57 months. Again, let’s look at total out of pocket costs:
Financing: $468.91/month x 7 years (84 months) = $39,388.44
Saving: $468.91/month x 4 years and 9 months (57 months) = $ 26,727.87
In this case we have a difference of around $13,000!
Of course the catch is that you have to put off making your purchase if you want to save up ahead of time and sometimes you just can’t wait (i.e. if your old car is falling apart!). So if you believe in the philosophy, maybe you should consider starting up your “major purchases” savings account – and get into the habit of only paying for medium to large purchases from the funds that accrue in that account… Over time, and by that I mean years if not decades, you’ll be able to make the transition from financer to saver! You can start out small – say $100 per month and work your way up from there. It’s a long road, but you’ll be happy you started now.