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Financing purchases can allow you to benefit from special financing offers and rewards, but may lead to debt. Cash purchases can help you avoid debt, but you miss out on the potential benefits of buying now and paying later.
You may consider using finance options such as credit cards, payment plans or loans when making a large purchase like a home or car, or when you need some time to pay off a purchase. You might also choose to finance a purchase if you want to earn cash back or rewards on a credit card. Before you make a decision, consider the benefits and drawbacks of financing versus paying in cold, hard cash. Here's when to choose each option.
Pros and Cons of Financing Purchases
When you choose to finance your purchase, you borrow funds with the promise to pay them back over time. Let's take a look at the good and bad points of financing.
- You can spread out payments. This allows you to make a purchase without tying up all your money at once or blowing your budget. Monthly payments can make paying for big purchases more manageable. With purchases like a home or car, it may be the only affordable way to buy.
- You can earn rewards. Charging a large purchase to a rewards credit card can earn you cash back, points or miles you can use toward other purchases, travel and more.
- It can help your credit. Making on-time payments can help you develop a solid credit history and prove to lenders you can be trusted with future loan opportunities. When it comes to credit cards, maintaining low balances is an important factor to helping scores.
- It can allow you to invest your money elsewhere. Financing frees up money to put toward retirement savings and other investments.
- Financing can increase the purchase total. Unless you open a credit card with an introductory 0% annual percentage rate (APR) and pay off the purchase before the intro period ends, you'll likely pay interest on your purchase. Depending on what you're financing and how long it takes you to pay off the purchase, interest can add up to hundreds or even thousands of dollars over time.
- It can hurt your credit. If financing purchases leads you to carry high balances on your credit cards, your credit score could take a hit. A high credit utilization ratio, or the percentage of available credit you're using on your revolving accounts, can lower scores. Also, if you forget to make a payment or pay over 30 days late, that late payment will hurt your credit scores and stay on your credit report for seven years.
- You may have less to put toward savings. If you're paying interest on several financed purchases, you'll have less money to set aside for your emergency fund, future expenses and retirement savings.
Pros and Cons of Paying Cash for Purchases
If you opt not to finance your purchase, you can instead pay in cash upfront. Just like financing, this option has its own benefits and drawbacks.
- Paying cash can save you money. If you finance a purchase, you may pay interest, which can add up. Paying with cash or debit means the price of the purchase is all you'll pay.
- You won't carry or add to your debt. When you pay with cash, you're not spending money you don't have—or even might not have in the foreseeable future. This can save you money and reduce the financial stress that can accompany carrying debt.
- It won't hurt your credit score. When paying for cash, you won't have to worry about credit utilization, monthly payments or credit inquiries, which can temporarily knock a few points off your score.
- Paying cash won't help your credit score. Because cash payments don't appear on your credit report and aren't considered in credit score calculations, they'll do nothing to help your score. When you make timely payments on a loan or credit card—which you can do without paying interest if you pay in full before the card's grace period ends—that payment activity will be factored into your credit score and can help it improve.
- You won't earn rewards for your spending. Paying cash means you're not collecting benefits like cash back or travel miles you might receive from a rewards credit card.
- It could deplete your savings. If you don't already have a substantial emergency fund in place, paying cash for a large purchase could leave you in a tough spot if an unexpected expense arises.
- You "pay" an opportunity cost. In other words, you won't rake in earnings from investing that cash or putting it into a high-yield savings account.
When You Should Finance
In certain circumstances, it may be better—or unavoidable—to finance a purchase. When you don't tie up all that money at once, you can take advantage of growth opportunities, like an investment strategy or high-yield savings account. If your potential earnings outpaces the interest you pay on a loan, financing is definitely worth considering.
Think about financing your purchase when:
- You can secure a low- or no-interest deal. If you have good credit, you may be able to qualify for a 0% introductory APR credit card that allows you to pay off your purchase for up to 21 months with no interest.
- You can stick to a payoff timeline. Low- or no-interest financing options can be fantastic, as long as you're committed and able to pay off your loan before the higher standard rate kicks in. If you don't have that type of deal, commit to paying off your debt as soon as possible, ideally before you're charged interest.
- You're buying a car. Over 85% of new car purchases are financed in the U.S., and it's easy to understand why: On average, new cars cost Americans $47,000 (or $28,000 for used).
- You're buying a house. Most consumers can't afford to pay cash for a home. The good news is mortgages carry lower average interest rates than many types of financing. You may also have the option to refinance for a lower rate or monthly payment down the road, and ideally see your property value increase over time.
When You Should Pay With Cash
Although financing is a smart option in many cases, it's not always the answer. Consider paying in cash rather than credit when:
- You're making discretionary purchases. It can be all too easy to swipe a credit card for concert tickets, new clothes, a dinner out with friends and more when you may not have the money in your budget to pay for them. This can lead to a debt spiral that could take years to get out of and could even end in bankruptcy. Paying with cash avoids that problem and can help you keep your budget on track.
- You don't qualify for good rates. If you're not eligible for a low-interest credit card or loan, paying with cash helps you avoid sizable interest charges.
- You're not the best at sticking to a financial plan. Anyone who is prone to overspending, missing bill payments or paying only the monthly minimum may be better off sticking to cash. Financing won't do you much good if it ends up generating late fees or mounting interest costs.
The Bottom Line
When it comes to your own bottom line, do the math before committing to financing or paying cash. First, check your credit score and credit report for free to see where you currently stand and find out if there are any steps that might help you improve your credit.
If you think you might qualify for a low interest rate on a credit card or loan, Experian CreditMatch™ can match you with offers based on your credit profile. Once you know the kinds of loans and credit cards that may be available to you, you can make a plan for your purchase and stick to it.