If you have a large emergency fund, it may be tempting to use that cash when you need to make a large purchase. But depleting your cash reserves is not necessarily the best approach in every situation. Financing a big-ticket item could also make sense, especially if you can take advantage of a great interest rate.
However, deciding when to finance or pay cash can be tricky, and your financial situation will play an important role in the decision-making process. In general, though, here are some instances where it makes sense to finance versus pay in cash, as well as the drawbacks and benefits of each payment option.
What Does Financing Mean?
In simple terms, financing a purchase involves taking out a loan or credit line to help cover its cost. For example, if you want to purchase a car (especially a quality or newer car), you likely don’t have the funds to pay for it all at once. Instead, you might take an auto loan from a lender and pay that loan down over time. Another common example is using a credit card with an introductory promotional rate to buy a new kitchen appliance. You repay your balance from there — ideally before the introductory promotional rate expires.
The Pros and Cons of Financing
While financing gives you the flexibility to repay a hefty balance over time, which is helpful, this method of paying for something comes with some drawbacks too. Here are the pros and cons of financing a purchase.
Pros
The primary benefit of financing is that it can keep your cash reserves intact, though it could also improve your overall financial situation. This assumes, of course, that your debts are manageable and you’re not in over your head financially. Pros of financing include:
- Large sum may not be required upfront
- Gives you time to repay your purchase
- Frees up cash for other purposes
- Positive payment history may help you build good credit
Cons
While financing can be smart in some cases, there are some cons to be aware of when you use new loan funds or a credit line to cover a purchase. Here are some of the major drawbacks of financing as opposed to paying cash:
- You may pay interest charges
- Taking on additional debt and monthly payments
- It could harm your credit score if you miss payments
Pros and Cons of Paying Cash
Like with financing, paying cash for certain purchases also has pros and cons. While using cash will help you avoid taking on more debt, it could deplete your emergency fund, depending on how much you’re spending. Here are some of the pros and cons of paying cash:
Pros
If you’re feeling overwhelmed with monthly payments or concerned about costly interest charges, cash could be a good choice. The pros of paying cash include the following:
- No additional debt or monthly payments
- Interest charges aren’t a concern
- Won’t impact your credit score negatively
Cons
Paying cash can be beneficial in some cases, but it also has some drawbacks. Depending on the size of your purchase, using cash could hurt your savings. Plus, it won’t help you build credit.
- Large sum may be required all at once
- May limit funds for other purposes or deplete your emergency fund
- Won’t help you build a positive payment history
When to Finance a Purchase
In general, financing a purchase can be a smart move if it’s a big-ticket item and you can access a very low-interest rate. But again, it depends on how much debt you already have and whether you can afford another monthly payment.
Assuming you don’t have significant debt and repaying a new loan or line of credit is feasible, here are some situations where it makes sense to finance:
Buying a Home or Car
Chances are you don’t have several thousand dollars set aside for buying a car or home. And if you did, using cash wouldn’t necessarily be the best decision.
Mortgages and auto loans generally come with manageable interest rates, currently around 6.12% for a 30-year mortgage and 6.55% for a 5-year car loan. Opting to finance large purchases like these could keep your cash reserves intact and allow you to invest that money elsewhere.
Low or 0% Interest Rate Options
Certain financing options come with low rates or even a 0% introductory annual percentage rate (APR) for a short time. For instance, many credit cards offer introductory APRs for a set period, usually 12 or 18 months. If you can get a credit card that offers this low rate, you can pay your purchase off over time without incurring interest charges.
Some credit cards even offer rewards for your spending, which can be an added bonus if you’re making a large purchase. But ensure you repay your balance in full before the introductory APR period ends, as credit cards typically come with a high regular APR.
Unexpected or Emergency Costs
If large, unexpected costs pop up, you may not have the funds on hand to pay for it, or doing so could deplete your savings entirely. For instance, medical bills are a common expense that people often choose to finance since they can be very expensive, making it challenging to pay out of pocket. In this case, a credit card with an introductory APR or a personal loan that allows you to access funds quickly could help cover the cost.
While financing big expenses could come with interest charges, depending on the option you choose, it will allow you to repay the amount over time. If you make your payments on time each month, your credit score may eventually increase—and there are many benefits to a good credit score.
When to Pay Cash for a Purchase
Paying cash could also make sense, depending on your situation. Here are some scenarios where cash is often a smarter choice than financing.
Financing Rates Are High
If you can only qualify for high-rate financing options, whether based on your financial situation or the current market conditions, it may make sense to pay cash instead. That’s because interest charges can add up quickly, making it more challenging to repay your balances. You could end up paying significantly more than your initial purchase amount due to added interest costs.
Increasing Debt Could Hurt Your Credit
Increasing your debt burden may not be a wise move if you’re working toward improving your credit. But again, this depends on your situation. For instance, if you opt to open a new credit card to finance a purchase, your credit utilization will likely increase. Since credit utilization factors into your credit score, this increase could harm your credit.
Paying Off Is Preferable to Another Payment
Portioning out a purchase into smaller chunks can be tempting, but sometimes the long-term cons outweigh the pros. If you have the funds to make the purchase upfront, it may be a better choice than tracking and managing another monthly payment, especially if you’re concerned about it slipping to the backburner.
Should You Finance Purchases or Pay Cash?
If you’re wondering, “should I finance or pay cash,” both options have pros and cons. It could make sense to finance if you can access a low-interest rate, or the purchase will set you back several thousand dollars. You probably wouldn’t opt to buy a home or car with cash, for example.
Financing could also help you improve your credit score over time, provided that you keep up with your monthly payments. But before you finance a purchase, it’s smart to check your credit report to review your current payments and debt levels. If you have significant debt, you may want to pay cash instead of taking out another loan or credit line. Always consider your financial situation first before deciding how to pay for a large purchase.
If you’re curious about your financing options, learn more about what SouthEast Bank has to offer! Our team of lenders can help you with personal loans, a home equity loan or line of credit, and more. Don’t hesitate to reach out or simply stop by your local branch to learn more.
