Today, financing seems to be everywhere. You can finance everything from an online purchase to a home remodel to medical expenses. Financing is not inherently good or bad; you just need to know how and when to use it.
This article offers a quick checklist to run through before you say yes to a payment plan.
Good Financing vs. Bad Financing
Two questions matter here: whether the purchase is worth making, and whether spreading out payments is the right way to pay for it. Unfortunately, many people skip the first question and proceed to the second because the payment seems manageable.
A few distinctions can help you separate financing that drains your budget from financing that works in your favor.
Financing Needs vs. Financing Wants
Needs solve a problem, such as a car repair or a broken tooth. Wants are nice-to-haves, such as a new TV or a vacation.
Wants aren’t off limits, but if it’s something you can’t save up for in a couple of months, hold off for now. Financing can make payments more manageable, but it doesn’t eliminate budgeting issues.
Waiting vs. Borrowing
Also consider which costs more: waiting or borrowing. For example, if you have a medical need or require a car repair, waiting can make the problem worse and more expensive to fix.
However, waiting may be a better choice if you’re buying an upgrade rather than a replacement, feel pressured to buy, or will still be paying for something after you stop using it.
Purchases That Hold Value vs. Purchases That Lose Value
Purchases like a reliable vehicle, a certification course, or necessary healthcare can be worth financing because they keep paying off over time, and some can even increase your earning power. Items that lose value, like a meal or trip, may be reserved for when you have the money saved up front.
The Financing Checklist: 7 Questions to Ask Before You Sign
Is this a need or can it wait?
Anything you need immediately, or that could cost you more if you don’t buy it right away, may be worth financing if it passes the rest of this checklist.
What does it cost in total?
Financing often comes with interest, fees, deferred interest, and penalties that can make the item more expensive over time. Compare the total paid with the sticker price before you commit.
Does the monthly payment fit your budget?
It’s easy to want to buy something when you realize that monthly payments are much more manageable than the total cost. But consider how your budget will look once you add this payment to everything else you already owe each month.
One simple way to decide whether payments are affordable is to calculate your debt-to-income ratio (DTI), i.e., all your monthly debt payments divided by your gross monthly income.
To arrive at this figure, add all your monthly debt payments plus the new payment, divide the total by your gross monthly income, and multiply by 100 to get a percentage. Lenders prefer a DTI under 36%.
Consider that DTI is based on pre-tax income, so it can make a budget look roomier than it is. Also check what’s left of your take-home pay after bills to determine if financing is affordable.
Will the purchase outlast the payments?
Some purchases come with payment plans that last longer than the item itself or how long you use it. This applies to vacations, concerts, some cars, and often appliances and electronics.
Do you have a backup plan if your income changes?
Payment plans can be especially difficult to maintain if your income changes because of something like illness or job loss. If this happens, will you have a backup plan, such as an emergency fund? Can you sell the item to pay off the balance?
How does it affect your credit?
Applying for financing that requires a hard credit check can temporarily lower your score. Defaulting on payments is also harmful, although on-time payments can build credit if the lender reports them to the credit bureau. You should especially consider the impact on your credit if you’re preparing for another major purchase or home shopping.
Is financing the best available option?
If you do decide to finance, compare the different types available. For example, you can choose whether to finance or tap into funds in a regular or health savings account. Or maybe employer benefits, like an FSA, make more sense.
If you choose to finance, will you use a personal loan, a credit card, or arrange a payment plan with the provider or a third party? Consider interest rates, fees, and flexibility to determine what best fits your needs.
Where Financing Makes the Most Sense: Healthcare
Whether to finance depends on several factors, but it often makes sense in one area: healthcare. Cost is one of the biggest reasons people put off treatment. About one-third (36%) of adults say they have skipped or postponed needed health care in the past 12 months because of the cost.
However, putting off healthcare typically costs you more over time. Problems get worse, reducing wellness, causing discomfort, and becoming more expensive to treat. That’s why, when paying upfront isn’t possible, a payment plan can be a better choice than going without care.
Fortunately, providers and third-party companies offer healthcare payment plans. Many offer interest-free periods, but read the terms carefully to avoid deferred interest. Find out if they require a credit check (many payment plans offer soft credit checks that don’t impact your credit score.
Before you finance, ask about sliding scale fees, financial assistance programs, and cash-pay discounts. You can also use HSA or FSA funds, and many of these options can be combined with a payment plan.
Red Flags That Mean You Should Walk Away
Here are some instances when a payment plan is definitely not going to fly:
- Pressure to decide on the spot
- Unclear terms or rates you can’t get in writing
- Deferred interest you’re not confident you can beat
- Financing to cover gaps in everyday living expenses
- A payment that only works if everything goes perfectly
To Finance or Not to Finance?
The decision depends on several factors, but generally, financing works best when it’s a deliberate choice, not the default. It should be an option when it fits your budget and when you use it for something that will add value to your life. The nice-to-haves can come later, when you’re more economically stable.
What makes you say yes to financing?
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