No matter how hard you try to stick to the ‘save now, buy later’ mantra, there will be occasions in life when you have to finance a big purchase by borrowing money.
Whether you’re planning a wedding, furnishing your new home, updating your computer or preparing for the arrival of a baby, the golden rule is to shop around for the best deal available. Once you’re happy that you’ve found it, pay in cash wherever possible – this may even secure you a greater discount on the item and you won’t have to deal with the stress of ongoing repayments and the extra cost of interest charges.
But if you don’t have the spare hundreds or thousands of dollars lying around that you need to complete the purchase, what are your options? Don’t automatically reach for your credit card, because although it may feel like the simplest way to pay, it’s also potentially one of the most expensive and can lead to spiralling debt if not carefully managed. Here are some of the other purchase options, and potential pitfalls to be aware of before you rush into any of them:
Consider the old-fashioned option
It might not feel very cool to ask your friend if you can come to their place to watch the match because you’re paying for your new TV by lay-by, but it can be a savvy payment option. First, you’re not paying any interest, and the extra charges (if the retailer charges any at all) are minimal. Second, you can pay for the item at a pace that suits you.
The obvious downside is that you don’t get your item until you’ve finished paying for it, which can be tough in today’s culture of instant gratification. Most stores are quite strict with lay-by periods, and for very expensive purchases this may not give you long enough to complete the payments. You may also find that some stores no longer offer lay-by as a payment option, because so many people have credit cards these days and with lay-by the retailer has the hassle and cost of storing the item until you collect it.
Know what you’re getting into with store finance
Many stores selling big-ticket items like electricals and furniture will entice you with ‘interest-free’ and ‘pay nothing for 3 years’ deals. You’ve no doubt seen them all over the place. Just remember, they’re not offering you a ‘buy now, pay later’ option out of the goodness of their hearts; this is just another way for them to fatten their profits.
If you’re not very careful to check what you’re signing up to, you can end up being hit with fees, charges and restrictions that saddle you with unexpected debt.
More often than not, these finance deals are provided through a third-party finance company which will send you a statement each month with a suggested minimum repayment. However, these payments are not designed to help you clear the debt before the interest-free period is over, and once it is up, your balance could be subject to rates as high as 30%. In addition, the credit provider has no obligation to remind you of when the interest-free period expires; it’s up to you to keep tabs on that.
IF you can work out your own payment plan and IF you’re disciplined enough to stick to it, you might just have got yourself a good interest-free credit deal. Oh but wait…
Have you factored in the fees that usually accompany these kinds of deals? There might be an arrangement fee, monthly account fees, and late payment fees if you don’t keep up. Even if you’re not being charged interest, these fees can make a purchase a whole lot more expensive so check them carefully.
And there’s more… some interest-free credit contracts come with the condition that you CAN’T PAY MORE THAN THE MONTHLY MINIMUM PAYMENT. This will completely scupper your chances of clearing your debt on your own terms and without accruing interest, so, again, check and double-check the fine print.
Bear in mind that the shop assistant you’re dealing with isn’t a finance expert, so don’t rely on them to answer any questions you have about the deal in question. Also remember that many of these behind-the-scenes finance companies don’t have much of a public image to uphold so won’t think twice about resorting to aggressive debt recovery tactics if you fall behind on payments. Mainstream banks, on the other hand, may be more flexible in revising your payment plan if you’re struggling.
One final word of warning about interest-free deals. The long timespans they offer may make the repayments super affordable, but do you really want to still be paying for your baby’s cot when she’s already grown out of it? There’s every chance your washing machine could break after 4 years and you’ll be stuck paying for it for a whole year beyond its lifespan. What if your relationship ends but you’ve still got 3 more years of paying for ‘our’ bed ahead of you? You need to factor in the element of the unknown, and the longer your payment term, the greater the chances of something happening to derail your current lifestyle.
If you do opt for a store deal like this to finance a big purchase, make sure it’s properly considered – not an impulse buy – and you’re confident you can make the most of the interest-free period on offer by carefully timing your repayments.
Store credit card? No thanks.
Do you think the retailer is doing you a favour by offering you a ‘complimentary’ store credit card with your purchase? Think again. This card will encourage you to shop at their store only – meaning you miss out on better deals that may be available elsewhere – and they tend to come with uncompetitive interest rates.
Better to turn it down or, if you find you’ve inadvertently signed up for one, cancel it straight away.
What about a personal loan?
Personal loans can be a pretty good choice if you need to take on debt to finance a big purchase. Although the headline rates may not be as good as in-store finance deals, they offer a fixed repayment schedule and a clear up-front picture of the total amount repayable so you can be fully informed about the cost of borrowing.
The time taken to arrange a loan, even if it’s only a day or two, will also give you a bit of a cooling-off period to make sure you’re really committed to purchasing the item in the first place.
When searching for a loan, do choose one with a provider that will let you make additional payments so you can reduce the term of the loan. Even paying back a small amount extra each month can make quite a difference to the interest you pay in the end, and if you have some extra cash in the future you might want the flexibility to repay your loan early.
As with any financial product, make sure you shop around first to be confident of securing the best deal available. Comparison sites make it easy to see what’s available on the market and will help you take into account not just the interest rate but any applicable fees. With some providers charging as much as $200 or $300 in application fees on top of ongoing administration fees, it really pays to work out the overall cost of the product – this is called the ‘comparison rate’.
Be prepared to look beyond the mainstream banks, as lenders like credit unions and building societies have traditionally been more competitive with personal loans. Online banking means you don’t have to worry about choosing an institution with a nearby branch, and there are increasing numbers of online-only banks to choose from.
Next, consider the term (length) of the loan. Choosing a shorter term will mean you spend less on interest but have to pay more back each month. The table below shows what a drastic difference a couple of years can make to the total amount you repay.
Cost of borrowing $10000 at 13% over different terms
|3-year term||5-year term||7-year term|
|Total amount repaid||$12 130||$13 652||$15 281|
|Overall interest cost charge||$2130||$3652||$5281|
The option to secure your loan
One way to reduce the cost of your loan is to provide some kind of security or collateral. The risk of loss to the lender is reduced because if you default on your payments they can claim possession of the asset offered as security.
Different lenders will have different rules when it comes to accepting securities. Some may accept a cash term deposit, others will require a percentage of equity in a property, and if you’re using the loan for a car they may take the car itself as security.
That’s not to say that if you pay the higher rates for an unsecured loan you can walk away from it any time you want. The lender may pursue you for the debt or hand the matter over to a debt recovery agency, and that’s when you get two burly guys dressed in black knocking on your door. If you owe more than $5,000 the agency can apply to have you declared bankrupt so this is not a decision to be made lightly.
So, a personal loan can be a good choice to provide you with a clear and structured repayment plan at a reasonable rate. Just be careful about how much you borrow because if you fall behind it could affect your credit record for years to come.
Access your home equity
If you already own a home and have built up some equity in it, consider using your mortgage to access extra low-rate funds to finance a big purchase.
If you have previously made extra payments into your mortgage you may be able to access this money via redraw. This means you don’t have to extend your loan, but it also comes with a redraw fee and cancels out some of that progress you made in paying back extra in the first place.
You also have the option to extend your home loan, meaning you access the additional funds at mortgage rates, which are usually the lowest on the market.
Although this option offers low rates, you need to be prepared to pay back more than the minimum amount each month otherwise the interest charges could add up to a lot more than you realise over the long term of the loan.
The table below shows how a long-term payment option like a mortgage can almost double the cost of whatever you’re buying. Say you borrow $7,000 for a new kitchen refit. It you tack that amount onto a $300,000 home loan charging 7% interest with 20 years remaining, it will add an additional $6026 to the overall interest you pay. That’s a pretty expensive kitchen!
In contrast, if you took out that same amount on a personal loan charging 13% over three years, you’d pay just $1491 in interest because the term is so much shorter. Of course, you’d have to pay back a much larger amount each month to make it work.
Perhaps the worst option is to pay by credit card and then only make the minimum payments. This would add an additional $10,256 to the cost of your kitchen and take an unbelievable 27.5 years to pay back.
Comparison of credit costs
|Home loan||Personal loan||Credit card|
|Time taken to pay off purchase, making minimum repayments||20 years||3 years||27.5 years|
|Interest cost||$6026||$1491||$10 256|
|Total cost||$13 026||$8491||$17 256|
If you do decide to finance a big purchase through your mortgage, you can help yourself keep up with the extra repayments by setting up a direct debit to automatically make the payment each month. Check your budget to see how much you can afford to set aside, and how long it will therefore take for you to cover the cost of the additional debt plus interest. If you think you’ll struggle to stick to these regular payments, a personal loan could be a better option for you.
One big-ticket item that’s noticeably absent from this article is a car – that’s because we’ve covered the process of financing car purchases in a separate article – take a look now if you’re interested.
Things to remember before you finance a big purchase:
- Don’t automatically use your credit card to finance a big purchase – the interest rates can be crippling
- Consider lay-by if the payment terms work for you
- Read the fine print VERY CAREFULLY before signing up for an in-store ‘interest-free’ deal. Take into account any extra fees and make sure you have the option to make extra repayments during the interest-free period
- Decide whether you really want to still be paying for your purchase several years down the line
- Say ‘no’ to store credit cards, or cancel them immediately
- Shopping around for a competitive personal loan provides a transparent finance option with regular repayments and a fixed term. Again, consider the fees and opt for the shortest term you can manage to minimise interest costs
- If you have a home, consider tapping into your mortgage but be prepared to make extra repayments otherwise the interest charges will skyrocket