Everywhere you turn today, there are companies who use advertising to tell you about the newest and greatest car, boat, television, computer and clothes. Credit card companies have slick advertisements showing happy people remodeling their homes, and lives, using their zero-percent interest rate credit card. Every product being sold today, regardless of necessity, can easily be purchased with one swipe of a credit card. None of these companies tell you what happens afterward, or how much that instant gratification will cost you.
The truth is instant gratification can cost you your financial future. Here’s an example.
Betty’s husband falls in love with a Sony 52″ flat panel LCD HDTV that is on sale for 15% off, for a final price of $2,499.99. Betty reminds her husband that they budgeted $1,000 for this purchase. The sales person suggests they apply for the 0% interest 3-year financing. They fill out the forms and qualify.
Betty mentions that their current television stand won’t support a television that big. The salesperson shows them television stands and they receive an additional 10% off a television stand for a final purchase price of $389.99. The salesperson then suggests purchasing an extra warranty that will replace the unit if necessary; this costs an extra $249.99. Delivery is free and they make the necessary arrangements. Betty and Joe are happy and feel they’ve done a good job finding what they needed on sale.
Total purchase: $3,139.97 + $188.39 tax = $3,328.36
Best Sales*, which uses Central Virginia Credit Company (CVCC)* for these contracts, states in the contract that the minimum payment is $10.00 per month. Once the three years are up, the interest rate becomes 19.8% with a default rate of 23.8%. If Betty and Joe pay a minimum payment of $10 per month for 36 months they will only have paid $360 toward their debt amount. They would need to pay a minimum of $86.86 per month to pay this debt off by month 36.
If Betty and Joe use the $1,000 they have in savings to pay for their purchase over the 36 months (a payment of $27.00 per month), they obviously will not have paid off the balance by the end of the term. Betty and Joe intend to pay the purchase off long before that. They decide they’ll use their tax return the following spring for the balance.
Let’s imagine, for a moment that Betty and Joe forget to do so and continue to only make the $27.00 payment each month. The house needs repairs, the kids need school supplies and clothes, and life just gets in the way. It’s important to realize that once the 0% interest rate period is over, a 19.8% interest rate applies to the entire balance from the date of purchase, not the remaining balance as many people assume.
At the end of 36 months, their balance would be $2,356.36 before interest is applied. At a 19.8% interest rate, their balance would now be $4,686.12. Their minimum payment now becomes 4% of their balance or $181.82. Because Betty and Joe are busy, and have forgotten they reached the end of the term, they don’t read their statement for one month. As a result, they send in their usual automatic payment of $27.00, causing a default. The interest rate increases to 23.8%.
Betty and Joe realize their error the following month and begin sending in the $181.82 minimum payment. If Betty and Joe never miss another payment, they would pay off their balance in 36 months for a total of $6,626.38 with interest totaling $1,940.26.
Think this couldn’t happen to you? That’s what millions of people have said and ended up in the same place that Betty and Joe will be if they don’t change their behavior: bankruptcy. The cycle becomes endless as people struggle to escape high interest rates by transferring balances from one 0% interest rate card to another, incurring outrageous fees in the process.
What could Betty and Joe have done differently? Betty and Joe were smart to budget an amount for a television. However, a flat screen HD television isn’t a necessity; it’s a luxury, plain and simple. This meant they had time to shop around for a solution that better fit their financial situation.
If Betty and Joe had internet access, they could have used the internet, where there are no pushy salesmen to put pressure on them. This would have allowed them to do their homework before walking into a store or could have ordered it from the convenience of their home. In this situation, Betty and Joe could have had a clear idea as to what features they wanted in a television and how much they were willing to pay.
After doing research, Betty and Joe would have realized that their figure was too low. They could have set up a plan to save enough money for the TV and found other forms of entertainment temporarily, went without, or used another TV in the house if one were available.
Joe and Betty could have also used Ebay, Craigslist and a variety of other sites online to find a used television with the features they wanted. This might have taken more time but could have saved Betty and Joe 25% – 50% of the retail cost, far better than the store’s discounts.
To avoid this situation in the future Betty and Joe could have sought out help in creating a cash flow plan to help them save money for future goals and large purchases such as this without putting a strain on their resources.
Of course, this goes against everything businesses want you to do today and is part of the reason our country has a negative savings rate. Betty and Joe’s spending behavior is unsustainable in the long term and is an example of situations faced by many Americans. Eventually, if it continues, more spending bubbles will burst in our country. The question for you is; will you be in one?
*Fictitious company names used as examples only.