Buy Now, Pay Later
by Gary Foreman
"Mom, you should see the neat new big screen TV that Jason's family just bought! It great! Man, I wish we could get one!" Mary chalked it up to her son's youthful exuberance and filed it away in the part of her brain for 'we'll get one some day'. What Mary hadn't noticed was her husband, John, who had overheard the conversation and was already dreaming about watching the Olympics on a huge screen. In fact, if Mary could have read John's mind, she wouldn't have been so surprised a few days later when he started pointing out the sale ads for (you guessed it!) big screen TV's.
"You know, Hon, these prices have really started to come down. We spend a lot of time watching TV. It's not like it's something that we don't use." Even Mary had begun to succumb to some of her husband's arguments. They began shopping and what they saw dazzled them. Stereo, picture-in-picture, a whole host of new options were available. Soon, even Mary had the 'big screen bug'. After a few weeks of shopping they had begun to settle on the features they wanted.
Then one day John spotted an ad for their local 'Super-Big Electronics Store'. In big bold letters were the words "12 Months: no payments, no interest, no money down". This was the message that John had been waiting for. He knew that much as they wanted a new TV, it wasn't in the budget that they had put together a few months ago. He also knew that they didn't have that much money in their 'mad money' account. John figured that they could probably scrape up about $50 per month.
But this offer made it easy. They could buy the TV now and budget it for next year. He was sure that they could fit the monthly payments into their plan. John couldn't wait to tell Mary the good news.
Much as Mary wanted the new TV, too (she wanted to watch the gymnastics on a big screen), she sensed that it was just too good to be true. So heeding that voice of reason she suggested to John that they calculate exactly what the TV would cost them using the 12 month plan.
By looking at their budget, Mary agreed with John that they could devote $50 per month to the TV. Knowing that, they got out some note paper and a calculator. (if you have a pc spreadsheet program it's even easier!) They created a sheet with eight columns. The columns were marked 'beginning savings', 'interest earned', 'ending savings', 'payment', 'beginning debt', 'additional interest', 'ending principal' and 'month number'.
"Let's start with the case where we take the store's offer of no payments for one year" suggested Mary. The set that they liked best cost $1,000 with tax and delivery. (fortunately for our writer!).
Mary began by putting $50 into the payment column for each month. They felt that they could begin to commit the $50 per month now, saving the money until the payments began in one year. Their money market account earned 4.5% annual interest so she put $.1875 in the interest earned column. She arrived at that by multiplying the $50 payment by .045 divided by 12 for one month's interest.
For month number 2 she added the $50.19 beginning balance plus the $50 payment and multiplied by .045 divided by 12 to calculate the interest earned. She figured they earned 37 cents that month. The ending savings was the beginning savings plus the $50 payment plus the 37 cents interest earned for a total of $100.56.
Following the same procedure for 12 months, she calculated that they would have $614.83 at the end of the first year.
Now for the part where they would have to pay the store. She began by subtracting the $614.83 from the $1000 that the TV cost. That left $385.17 which Mary entered under beginning debt.
To calculate the additional interest she used the stated interest rate of 23.9%. She multiplied .239 divided by 12 by the beginning debt of $385.17. The answer of $7.67 was entered under addition interest in month #13.
She figured the ending debt by adding the beginning debt and the additional interest. To that number she subtracted the $50 payment that they would make each month. She calculated that they would owe $342.84 at the end of the 13th month. Naturally, that same number was the beginning debt for the 14th month.
Mary repeated the calculations for each month. She estimated that they would have the TV paid off in the middle of the 21st month. Totaling the payment column revealed that the Smiths would be paying $1,022 for the TV.
John ruefully reminded Mary that they had tried this before and hadn't saved anything until it was time to begin making payments. He began to calculate what the TV would cost under those circumstances.
His worksheet was simpler. He had five columns: 'beginning debt', 'additional interest', 'payment', 'ending debt' and 'month number'. John put $1000 in the beginning debt column and began to calculate. The additional interest was calculated just like Mary did it. The beginning balance was multiplied by .239 divided by 12 months. He was surprised to note that the first month's interest equaled $19.92. By adding the beginning debt and the additional interest and then subtracting the $50 payment he arrived at the ending debt of $969.92.
John repeated the steps month by month. Soon he was tired and wondered if the TV would ever be paid for. His answer came in the 26th month! By totaling the payments he realized that they would be paying $1,288 for the TV. Boy, that was like a 30% premium!
Mary thought that maybe the problem was the 23.9% interest that the store was charging. She wondered what would happen if they just used their 14% credit card and began paying now. She used the same column headings as John had. The only difference was that she calculated additional interest by multiplying .14 divided by 12. Her first month's interest was only $11.67 vs. the $19.92 that the store was charging according to John's figures.
After 23 months Mary had the final answer. They would pay $1,145 for the TV. That was better than the store's deal, but still was nearly a 15% premium for having the TV now.
They poured another cup of coffee and discussed the matter. "I wonder what would happen if we just started putting $50 a month away and bought the TV when we had the $1,000?"
John marked a sheet with columns: 'beginning savings', 'interest earned', 'payment', 'ending savings' and 'month number'. John entered the familiar $50 in the payment column. The interest earned was the .045 divided by 12 and multiplied by the beginning savings plus the $50 payment. In the first month it was only 18 cents.
The ending savings was the beginning savings plus the $50 payment and the interest earned. It was in month 20 that John reached the magic $1,000 level. By totaling the payment column he realized that they would be paying $960 for the TV. That was over $300 less than using the store's headline offer!
Mary and John didn't reach a decision that evening. In fact, we're not even going to tell you what they finally decided. After all, what they decided might not be best for your family.
But the methods they used can be repeated anytime you face a major purchase. If you think it through and do a little calculation (a spreadsheet program makes it even easier) you can make an informed decision that best meets your needs.
Happy shopping (and saving)!
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and he's a regular contributor to CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.
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