Advertisements

Debt Myth #3: “I Can Make the Payments!”

Via Flickr, by user Images_of_Money. Used under Creative Commons License.

Beware of the Payment Trap.

One of the oldest tricks in the car dealership playbook is for the salesperson to lead potential customers into the Payment Trap. A customer comes on the lot, picks out a car, and takes it for a test drive. If they like it, the next question out of the salesman’s mouth is this: “What kind of monthly payment are you looking for?”

The customer thinks it over for a second, and says something like “I can probably do $250 or $300 a month.” Answering this simple question, they’ve just walked right into the trap. “We can definitely make that work,” the salesperson says. They go into the office, do some number crunching, and find a way to finance the purchase so that the customer has a monthly payment of around $300.

The average customer has no idea that they’ve been tricked, but the salesman has cleverly steered the negotiation away from the real value of the car, and walked the buyer into the payment trap. By setting up payment terms that the customer likes, the dealer has made them think that they’re getting a good deal; meanwhile, he’s charging a premium price for the car, much higher than what he would have charged a savvy negotiator. And the company stands to make another tidy sum from the high-interest financing deal that they arranged to get the customer into the payments they wanted.

This isn’t an article about buying cars, but the story above demonstrates the dangers of the Payment Trap. One of the most common misunderstandings in American personal finance is that debt is no big deal, as long as we can “make the payments.” On everything from cars to furniture, electronics and entertainment items, we buy more than we can afford, stretch the payments out over several years, and get to take the item home today. Since we’re fixated on the monthly payments, we’re distracted from the real value of the item, and miss the opportunity to negotiate (paying with cash can often bring the price down) or to shop around for a better deal. Plus, since we have to pay interest on the loan, the item ends up costing us even more than the advertised price.

The Payment Trap can be especially dangerous when it comes to credit cards. Many American consumers rationalize their credit card debt this way: “I have a balance on my credit cards, but it’s no big deal, because I can always afford to make the monthly payments.” This is an illusion. Sure, you can make the monthly payments, but on most credit cards, the minimum monthly payment is calculated by adding the new interest charges for the month to 1% of the balance on the account. That means that it if you only make the minimum payments, it could take 100 months (more than 8 years) to pay off the  balance of the card; during that time, you’ll also be paying interest on the balance, which can add many thousands of dollars to the true cost of the items you’ve bought. And if you continue using the card, adding more to the balance each month than what you pay off, you create a vicious cycle of debt and interest that you’ll never escape.

Thinking about big purchases in terms of the monthly payments causes us to pay too much for the product, and then we pay even more in interest. And while it may seem easier to work a “low monthly payment” into your budget, the extra money you’re shelling out by borrowing could be used to save, to give, to be a blessing to others, or simply to have fun. You could even use it to save for the next Big Shiny Thing that you’ll want to buy.

Remember, just because you can “afford the payments” doesn’t mean that you can afford the purchase. And it almost always means that you’re getting a bum deal in the proccess.

By the way, what’s the best way to avoid the Payment Trap when you visit the car dealership? Just respond with this simple, powerful answer: “I’ll be paying cash.”

Advertisements

Trackbacks

  1. […] Think about it: Do you need to eat out three times a week? Do you need a new Macbook Pro every few years? Does your family need a late-model SUV, or could you get where you need to go in an eight-year-old station wagon that you paid cash for? […]

  2. […] debt sticks around until you pay it all. Many of these loans have low interest rates, and “affordable” monthly payments, but are structured to last for 20 years or more. If you borrow tens of […]

  3. […] They’ll say that some debt is good debt, or that carrying debt is okay, as long as you can make the payments. But once you debunk all the myths and walk them through all the math, you’ll come down to […]

  4. […] debt. You’ve realized that borrowing decreases your buying power; that just because you can afford the payments doesn’t mean that you can afford the purchase; that it isn’t impossible to live […]

  5. […] or trim another spending item from your budget until you have the cash you need. Whatever you do, don’t go in to debt to buy a […]

  6. […] afford to pay for when the monthly statement came. Sure, credit cards can have lots of high interest rates and tricky payment terms that make it easier to run up debts. But in the end, the debt only exists because I chose to buy […]

  7. […] we look past the slick marketing, the slippery payment terms and our collective cultural obsession, though, we’re left only with math. And math tells us […]

  8. […] With the exception of purchasing a home, borrowing money is never, ever a good idea. Unfortunately, many hobbies can entail purchases that cost thousands — or tens of thousands — of dollars. If you find yourself borrowing money to fund your hobbies, stop immediately. The fun that you’ll have with the purchase is not worth the bondage it brings in the long term. Hobbies should always be paid for in cash with money that you’ve saved. Don’t ever borrow money to buy a hobby item, even if you think you can afford the payments. […]

  9. […] Most credit cards and many other kinds of debt offer attractively small monthly payments, which can lead you to believe that it’s okay to borrow as long as you can afford to make the payments every month. The trouble is that these low minimum payments consist mostly of interest, and make a very small dent in the principle balance of what you borrowed. Paying the minimums means that it will take years for you to finally pay off the loan, and over the course of that time the interest payments can match or even exceed what you borrowed in the first place. Low payments are bait on a hook that will hold on to you for years. Learn more here. […]

  10. […] fact is that you can’t see the future, and a monthly payment that seems affordable now may be unattainable if you have some other financial setback in life. Borrowing money ties up funds […]

  11. […] those payments on the extra money that you have each month. But as we’ve discussed before, just because you can afford the payments doesn’t make debt a good idea. If you have a job loss or other life emergency, your ability to make those extra payments can […]

  12. […] if you owe tens of thousands (or even hundreds of thousands) of dollars to various lenders. Making minimum payments is no way to go — it will take many years to get out of debt if you go that slowly. If you […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Copyright Brian Jewell, 2011-2013

All of the contents of this site and its posts are copyright of Brian and Laura Jewell. Any redistribution or duplication of this material, without the consent of the authors, is strictly prohibited. Instead, please feel free to link to us. Thanks!

Disclosures

All content on this site is given on a general basis and is intended for informational use only. The content does not reflect any professional legal, investing, accounting or tax advice, and should not be used as the sole basis for making financial decisions. Always consult a certified financial professional before investing.
%d bloggers like this: