While I’m a big proponent of saving cash for medium to long term purchases – whether it is for your next trip, your next car or some new furniture – sometimes it just isn’t possible.
If you start saving for a big renovation which needs to get done next year, chances are you won’t have saved enough by next year.
This might be the case for your next car too. While it is great progress to go from saving nothing, to putting away, say $100 or $300 a month – designated towards a specific future purchase – it can take a few years before the system is working. Saving cash for future specific purchases is all about creating an intentional plan for your money, staying out of debt, and over time making sure you are living within your means, INCLUDING these purchases.
An example might help. Let’s consider next year’s $10,000 Window Project. Even if you tuck away $300 a month towards the Project over the next 12 months, you won’t have enough since you will have only saved $3,600. So, what to do about the remaining $6,400 you need?
The most popular go to: The line of credit. Unfortunately, there is one guarantee in life – Lines of credit are never paid off according to the original plan. Lines of credit are great for two reasons: They typically charge a low rate of interest, and they are easily accessible. And they are terrible for two reasons: They never need to be paid off and they are easily accessible. Yes, their ease of access actually hurts you – it is just too tempting for most of us to have access to easy credit and not be tempted to use it – for purposes never intended.
What I recommend for larger medium term purchases, when there isn’t enough time to save for them with cash, is the Term Loan. This dinosaur of the banks is still available but you won’t hear them promoted much. Why? Because they are contracts with payments comprised of both interest and principal, and when the term of the loan is done, so is your debt.
If it sounds familiar, it’s because this is how the car loan and mortgage work. I love the term loan for the same reason you eventually own your home. Any contract that demands a loan is fully paid off by a set date, means it actually gets paid off. Lines of credit and credit cards are cash cows for the banks, because they often go decades without being paid off.
So, the next time you are wondering which bank product to use to finance a purchase. #1: Try to save cash. If there’s not enough time to do so, go for #2: The Term Loan. If you are interested in staying in debt for longer than you should, with low payments, cheque and online access, balance transfer offers, and brochures with a lot of smiling faces – consider the line of credit.