When we want to buy big assets, especially, there is always the question of whether to use financing or pay cash. This question is likely to cross your mind as an adult handling finances. If you’ve struggled with this, you should read this article comparing financing vs paying cash.
Financing
Financing allows you to make purchases without touching your cash reserve. It involves taking out a loan or using a credit card to make a purchase. This might seem easy for many people as it keeps your cash reserve intact. But is it really the best option? Let’s look at the pros and cons.
Pros and Cons of Financing
With financing, you can take a loan that spreads through a period of time and avoid paying a large sum at once. However, this doesn’t mean there are no disadvantages. Read on for the pros and cons of financing.
Pros of Financing
1. Flexibility
Financing has several payment and repayment options. You can check out different plans before choosing the perfect one for you. That way, you have better control of your finances.
2. Allows for More Purchases
Financing frees up money to make other purchases. For instance, if you need to buy a large asset like a home or car. After making that purchase with cash, you may be unable to make other purchases. However, with financing, since you are not dropping a lump sum, you have the opportunity to make other purchases that are also needed at the moment.
3. Easier on the Budget
Financing is easier on the budget in the sense that you don’t have to pay a hefty sum upfront. That way, you can spread the payment across several months or years, as the case may be. You can make plans in the budget to repay every month, making it easier on your account.
Cons of Financing
1. May Put You in Debt
The most obvious drawback to financing is that it could put you in debt. Many have found themselves in unending debts because they take loans or use credit lines to cover costs. If you miss out on paying some months, the debts keep accruing, which could greatly harm your finances.
2. Interest Charges Add Up
Most financing repayment options attract interest. They accrue more when you miss a payment. However, even without that, a little interest is usually required, which would increase the total purchase cost. Depending on the type of purchase and repayment plan, this might not be more than a few hundred, but it could accrue to thousands if you default on repayment.
3. Could Hurt Your Credit Score
If you pay your debts on time, you won’t have an issue with this. In fact, it could improve your credit score and earn you a good reputation with lenders. However, defaulting on payments can hurt your credit card score, portraying you as a high-risk borrower. The consequence of this is that you will likely only assess high-interest-rate loans.
Also Read: How to Live Within Your Means
Paying Cash
In this context, paying cash is not literally exchanging cash for products but dropping the money upfront when purchasing assets. It means paying the total agreed amount when making a purchase. For some people, this might seem like the wisest financial decision, but it also has its advantages and disadvantages; let’s discuss them.
Pros and Cons of Paying Cash
Paying cash will help you avoid debts, but that doesn’t always make it the best option. Let’s look at the pros and cons of paying cash.
Pros of Paying Cash
1. Avoid Debts
Like the most obvious drawback of paying cash is being in debt, the most obvious advantage of paying cash is that you can avoid debt. There’s no risk of debt when you pay for purchases upfront; you can buy an asset and be done with it.
2. Doesn’t Hurt Your Credit Score
Paying cash doesn’t hurt your credit score because you are not using the credit line.
3. Helps with Budgeting and Saving
Paying cash helps you keep a realistic budget because you only purchase things you can afford. You are able to keep better track of your income and expenses. It also helps with savings because you are not worried about repaying debts every month, so you can save more.
Cons of Paying Cash
1. Could Deplete Your Savings
If you have to pay cash upfront, it may require dipping into your savings or even emergency funds. Of course, this depends on the kind of purchase and how much you earn. However, for the average person buying large assets, paying cash will likely cause a huge dent in your savings.
2. May Stop Additional Purchases
When you pay a lump sum for an asset, you may not be able to make additional purchases for a while before getting your feet back. In some instances, it can also stop savings because it depletes your finances and makes it difficult to have room for anything else.
3. Won’t Help With Your Credit Score
Cash payments do nothing for your credit score because they do not appear in your reports. So, if you require a loan sometime in the future, lenders will have no precedent to bank on to offer you favourable plans.
Of course, they don’t hurt your credit score either and may not be a factor if you never use your credit line, but you just never know. Using your credit line or taking loans and repaying them in record time improves your credit score and reputation as a lender.
Financing vs Paying Cash: Which Is Better
Having discussed the pros and cons of both payment options, how do you decide which is best for you? There are certain factors to consider when choosing which is better for you. Note that you don’t always have to pay in cash and vice versa; you can decide what works best for individual purchases.
Having said that, let’s look at the factors to consider.
1. Type of Purchase
Large assets that would severely deplete your savings and force you to dip into your emergency fund are better purchased through financing. It is not expedient to be unable to purchase anything else or survive because you made an equally necessary payment.
So, to fund a car or house purchase, you can consider financing, but with a strict repayment plan, so you don’t run into debt.
On the other hand, swiping a credit card for discretionary spending is not advisable. Use a debit or pay literal cash for purchases like ordering food, gas, clothing, concert tickets, etc. Even your bills should be handled with money by including it in your monthly or weekly budget.
It can be easy to fall into the temptation to swipe a credit card for these purchases, but doing so will cost you in the long run.
You should also avoid financing for luxuries; make sure to use them for necessities or assets that will bring in a profit. For instance, your family might need a car, but if you can’t afford it, you don’t need a luxury car when you can get a functional and valuable vehicle.
2. Income
You can afford to pay even for a house upfront, depending on your income. If you earn high and can save for a few months to buy upfront without dipping into your emergency fund or other savings, then you should.
On the other hand, avoid financing assets when you cannot earn enough to repay them. You will accrue more debt and make your financial situation worse. Instead, look for ways to improve your finances and consider purchasing certain assets.
Also Read: Common Financial Mistakes to Avoid for a Wholesome Life
3. Credit Score
A high credit score allows you to get better loan deals, while a bad credit score does otherwise. If you have a bad credit score, it means you are in debt or usually have a hard time paying them off.
Taking more loans will mean swimming in more debts because not only are you adding to what you already have, but you will hardly get good rates and have to pay far more than the initial cost. Remember that lenders don’t offer good rates to borrowers with bad credit because they are high-risk.
If you fall into this category, pay cash for necessities until you can get back on your feet and improve your score.
4. Your Relationship with Money
If you are not shrewd with money and are prone to overspending and defaulting on payments, you are better off paying cash. Financing will harm your finances because you can’t manage the situation properly. So, buying only what you can afford or saving towards what you cannot is better.
If you don’t have a good relationship with money, it could still affect your savings ability. To help you, you can use saving platforms and permit them to autosave a specified amount on your behalf. I particularly use PiggyVest for this, and I swear by it.
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