In many of our past articles, we’ve written about the dangers of using interest-free credit to pay for stuff on instalments. While they offer the prospect of using free money, at least for a little while, they often come with risks to your financial well-being.
If you’re still wondering what kind of “risks” can exist when using free money, we’ve written this article to highlight seven things (and we could think of a few more even) that you need to think about to protect yourself financially.
Of course, these considerations are for people who are (or choose to be) ignorant. If you’re great at keeping tabs on your expenses and are financially prudent, some interest free instalments make great financial sense. We highlight four reasons it may make financial sense to use interest-free instalments to pay.
#1 When The Money Is Really Interest-Free
If you’ve read the article we highlighted above, you’d realise that in many scenarios, you’ll actually be slapped with hidden processing or administrative fees and even be forced to pay a membership fee.
You may also be financially worse-off in other ways, such as not receiving the credit card perks, such as miles, cash back or points, that you would have otherwise received.
Some scenarios you may face with this decision in your every day life include wondering whether to pay your income tax in full or in 12-monthly instalments; negotiating credit terms for your purchases with businesses you’re familiar with (the writer did this when he installed new air-cons in his home); and even on loans from your family and relatives.
We’re not telling you to go out of your way to start doing these things, especially for the second and third scenarios, we’re just saying it makes financial sense if you were put in the position.
#2 When It Makes Economic Sense
When it makes economic sense to keep your money, you should always choose payment terms in instalments, interest-free or otherwise. Yes, that’s right – regardless whether you have to pay interest or if you find that there is going to be a hidden fee on it.
To explain this, consider this scenario: if you have $50,000 invested in real estate investment trusts (REITs) on the stock market, and you’re receiving a return of close to 5%-7% on that money, it may make economic sense to buy your furniture from Courts on an instalment-free payment term.
Even if you’re hit by some hidden fees or lose out on credit card perks, you may be better off holding on to your investments.
Understanding this gives you the ability to objectively decide if you’re going to be better off growing your money in an investment or using it to pay for a purchase.
#3 Achieving Free Liquidity Buffer
This concept is slightly harder to appreciate. Some of us on the DollarsAndSense team disagreed whether it qualified or not, but the writer insisted it did. (Let us know if you agree or disagree with this point).
The premise here is that by paying for a purchase in instalments, you’re creating a free liquidity buffer for yourself.
Imagine if you had to pay down $5,000 over three years for a multi-year gym membership that includes personal training slots. By choosing to pay it over 36 months, you’d have to fork out approximately $140 each month. You now add this sum to your monthly expenses, and keep the $5,000 as your liquidity buffer.
How this works is that this $5,000 becomes your three- to six-months emergency funds. You now have a monthly expense that includes the additional $140 payment to deal with as a financial commitment each month.
If you’re worried about this being financially reckless, we argue that this is actually being more prudent. If you had opted to pay in full from the onset, you may have been put in a scenario with zero in emergency funds. You now have $5,000 that you can use to pay for your monthly financial commitments in the event you lose your job or suffer another financial setback.
This also means you don’t need to allocate more money to keep an emergency fund, thus allowing you to invest an additional $5,000 to earn returns rather than sit in your bank account.
#4 Being Able To Afford Something
The last reason we present is a lot more straight-forward. If you’re just starting out in life or in a position where you cannot afford things that you really need/require, it might make sense to use an interest-free instalment.
There are a few scenarios where this may happen; furnishing your home is one good example. Rather than moving into your home without some essential furniture and household appliances, you can decide to take some on instalment if you’re prudent or even get a loan from your parents.
Another scenario may include getting a tuition fee loan in Singapore. Local financial institutions work with the government to provide this to students who qualify, enabling them to receive interest-free loan up to two years after they finish their education, and requiring equal monthly instalment payments of as little as $100.
We’re sure there are numerous other reasons and scenarios where paying in instalments makes sense and is actually the more prudent decision. Do share with fellow readers on our Facebook page if you have any others.