This or That scenario
I apologize if this has already been debated somewhere.
Assume that two large purchases have been budgeted for, say $3,500 for a fridge and $2,500 for a new mattress & bed frame. So, $6,000 total saved.
If you can make both purchases using 0% interest and can afford the monthly payments being added to your monthly expenses - what are the downsides of using that $6,000 toward a different debt that does have an interest rate attached to it, when the time comes?
I'm open and excited to hear the pros and cons of owning the fridge and bed outright with no installment, or adding the installment payments but paying a loan off early.
A common pitfall is using the $6000 to pay down the debt (say a credit card) and not addressing the reasons the debt accumulated in the first place. Over time, the debt comes back, and now you have two additional monthly payments for the fridge and mattress, and the equivalent of the debt you started with.
The next "gotcha" is not paying off the 0% interest purchases before the teaser rate expires. Those deals are usually structured to stick you with all of the would-be interest if you don't pay it off by a certain date.
Cash makes a very good point. I agree in prioritizing/budgeting for the things I’m already paying off (especially if they’re costing me interest) so I don’t end up getting further into debt the next time those expenses are due. If that debt also includes things that aren’t regular expenses (splurges on things I didn’t need or plan for, or just spending more than I made), I’d want to also make sure I have a handle on frivolous spending or my income/expense ratio first. I’d also want to be very comfortable with my job stability.
I’m a debt-adverse person (obviously with this list!😆), so these are the things I’d want to know/analyze before making any final decision:
- Do I really need this new thing (or things) right now? Can I delay this purchase any longer?
- Do I want to add $6000 to my current debt (because that's what financing this new purchase means, even at 0%)? How does that affect my debt-to-income ratio and credit-score (especially if this could have any bearing on any other financial decisions I need/want to make in the near future)?
- How much is the total amount owed on my outstanding interest-accruing debt?
- How much is the interest rate on that outstanding debt? (If the debt is at multiple creditors, what are all those rates?)
- How much interest am I paying each month on that debt?
- At the current rate of payment, how long (in months) before this existing debt is gone?
- How much total interest will I be paying for the remainder of that time?
- How long is the term (length in months) on the 0%-Offer?
- If I didn’t pay it off within that time frame, what does the rate increase to?
- Will that rate be applied to the original balance of the financing, or just the remaining unpaid balance?
- Are there any other fees I’d be responsible for if it isn’t paid off within the terms, and how much are those fees?
- How long did it take me to save the $6000 for this purchase?
- Was that time frame longer than the 0%-Offer term length? If so how much longer did it take to save this up?
- Was this accomplished with "extra" funds from my regular income only, from a bonus, a windfall, or some combo...?
- Could I afford $375/mth without dipping into that $6000? (*6000 divided by 16: if I chose to take advantage of a 0% rate, I’d want to pay it off before the term. If it was an 18-month term, I’d plan on paying it off in 16 months instead.)
- If not, how much income is leftover each month after all my expenses/existing debt payments are budgeted for? Using that leftover amount, how long would it take me to pay off this 0%-Offer with just those funds?
- If that time-frame is more than the 0% term, how much would I need to dip into the $6000 bucket to pay it off on-time?
- What if I split the difference and applied $3000 to my debt and $3000 to the 0%-Offer (or some other split amount)?
- How does that affect interest payments, and debt payoff time?
- Can I make the $Min monthly payment to the 0%-Offer for 16 months reducing it by $X-amount upfront?
- What happens if an unplanned expense pops up? Could I afford to take on that ($nebulous) debt? Do I even have another way to pay for it (what if my credit is already maxed)?
I could go on…
I’d definitely use some of the interest rate/debt calculators out there to run through your options/scenarios.
Good luck. I think it can be worthwhile to take advantage of those offers, but only once we’ve given ourselves the opportunity to really make sure it’s our best interest to do so!
I may be oversimplifying here - but what you’re saying is you have $6000 assets, $6000 debt and a desire/need for some new stuff.
So your options are:
a) pay for the new stuff with cash, continue to pay down the debt at xx%
b) finance the new stuff at 0%, replacing the old $6000 debt at xx% with a new $6000 debt at 0%
c) repay the debt and don’t buy the new stuff 😉
Difficult to know exactly without knowing what the repayment term/monthly payment structure etc is, but in my view if you can swap a $6000 debt for a cheaper $6000 debt with no other change that’s a no-brainer. But I added c) to illustrate that you always have the option of spending less/not spending too 😎
Great question, Gold Trombone ! So many great points made so far! One thing I'd add is that I like to keep my budget as simple as possible - to me, it is more important that I have just a few accounts, and make sure I am not juggling balance transfers. It's not a matter of managing transactions in YNAB, it's more like minimizing decision fatigue. If I already had the $6000 budgeted, I'd rather pay for those items in cash, and continue to pay down my debt as planned. I know I'd start to go down a slippery slope of questioning each purchase with this same lens, rather than focusing my energy on budgeting for all of my new expenses AND paying down debt.