Many moons ago, when my wife and I moved into our first apartment, it did not take long for us to tire of our weekly trips to the Laundromat. If memory serves, we made two trips to the coin laundry before we decided to buy our own washer and dryer. This was back when we were a little less careful with our money, so we headed to a box store that was offering 12 months, same as cash. Little did we know how close we were to a financial train wreck.
We walked through the box store and selected a washer/dryer set with a well-known brand name. We told the salesman of our choice and said we wanted the 12 months, same as cash offer. He whisked us over to a customer service person who had us fill out a credit application. This particular store actually ran their credit applications through a different company.
Thirty minutes later, we were setting up delivery for the washer and dryer. Several home-based loads later, we received a coupon book in the mail. The credit company sent us a coupon book, where we would tear out the appropriate monthly coupon and mail it and the check to the company.
Here's the catch: my wife noticed as she wrote the second monthly payment that if we paid the amount on the coupon for 12 months, we would not have paid off the full amount of the purchase. We began scanning through our documents and found that if we paid what the company requested, we would be hit with a financing charge of 19%. Even worse, the 19% interest would be applied retroactively, meaning that we would owe interest on the full purchase amount, not just the amount left unpaid after a year. Their coupons were calculated on a two-year schedule, not a one-year schedule... and they did not even include the interest that would accumulate!
We had been suckered into a perfectly legal scam. The next month, we paid the full amount due to be sure we did not get hit with the interest charges.
Same as Cash Deals
Many stores offer special promotions allowing you to buy expensive items and pay for them over time. In order to do this, you will apply for credit either through the company or a contractor that they use. If you have purchased something on a same as cash basis, realize you may have been trapped.
Check your monthly payments to make sure you are paying enough to pay off the whole purchase in the specified time. There may be, buried in the fine print, information stating that you will be hit with finance charges if you only pay what they say you owe. It's not much different than a credit card, where if you pay the minimum monthly payments, your credit is good, but you pay crazy interest rates on your purchases.
In today's credit environment, you could even have two hidden interest rates. There might be the one that applies if you do not pay off the full amount in time. There could also be a second, "default," rate. The default rate can apply if you miss a payment or send a payment in late. Depending on the loan, the default rate could apply if any loan that you have is paid late... credit card, auto, mortgage... any loan. And the default rate could be 10 or 15 percentage points higher than the regular rate (in many states, the default rate can be 29.99%!).
So how do you avoid this type of debt trap? Simple. Don't buy on credit; pay cash for your purchase. There are four advantages to doing this. First, you don't get tempted into buying something you cannot afford. Yes, you might be able to afford the monthly payments, but the reality is, if you have to take a loan to buy a new TV, or washer and dryer, you cannot afford it.
Second, paying cash also keeps you in your budget. If you go into the store with a fixed amount of money in your pocket (or checking account), the salesperson cannot talk you into a more expensive item because you won't have the cash for it. Financing makes it easier to spend more.
Third, you avoid damaging your credit score. Part of your credit score, also known as a FICO score (named after the company that developed the system), is calculated on your total debt used. For example, if you have a credit card with a $5000 limit and have $500 on it, you are using 10% of your credit. If you take out a loan to buy a new TV, the new loan might be for $2500, $2000 of which is used for the TV. Now you are using $2500 of your $7500 in total credit, or 33%. This makes your FICO score drop, which can end up raising your interest rate on a more important purchase, like a house.
Fourth, paying cash can save you money. For example, when we bought furniture for our first house, my wife and I were at a store offering six months same as cash. We offered to pay cash instead of financing and asked for a discount; the store knocked 4% off the price. Four percent off a $3000 bedroom set may only be $120, but that's enough for a really nice dinner with your significant other.
Ever notice that some gas stations offer a lower price for cash transactions than credit card purchases on gas? Asking for a discount can work in your favor even if you offer to pay cash instead of place a purchase on your credit card. The company pays a fee, anywhere from two to five percent, to the credit card company when you charge an item. Offer to split they credit card fee... you get half as a discount and the store gets half as additional profit.
Buying an expensive item on a same as cash basis seems like an easy way to get what you want, but it can lead to complications. You can get tricked into paying interest, as well as spending more than you originally planned. You risk damaging your credit score and miss out on the chance to get a discount by paying cash.
Yes, it is harder to get the items you want when you have to save. But, you save yourself a number of potential hassles. As I tell my recruits when I am their FTO, "Learn from my mistakes; there's no need to learn the same lesson twice."
Be safe and shop smart.