Pay up front, or in installments?

When making a big purchase, or even a not-so-big purchase, do you pay in installments? Here's how to find out …

“Pay on the installment plan.  Don't pay now; pay later.  Five easy payments of $39.95.”

When businesses offer to split up the payments in a large purchase, it usually brings them more business.  If the pain of buying (the cost) is lower, or appears to be lower, more people will buy.

Businesses, of course, don't offer this out of the kindness of their hearts.  They want extra money.  Paying through installments almost always costs more — either through payment fees, or through interest.

Most installment loans are expensive

My wife and I haven't gone into many retail furniture stores together, but I remember one visit in particular.  Within twenty seconds of entering the store, we were greeted by a salesman who told us about the specials going on.

I don't remember the brand, or even the amount, but I do remember that he quoted the amount per month.  We didn't spend a whole lot more time in there after he did that.

Most consumer loans are either (a) expensive, or (b) 0% for some period of time but get really expensive if you miss a payment.  The low payment, or the low payment and the promise of low interest, are there to get you to seal the deal.  And they must work, or businesses wouldn't continue to offer installment plans.

There are costs to paying in full, though!

The expense of most installment loans can't be ignored, but, as always, there is the other side of the coin to consider.

Paying cash, on the whole, is often wiser than paying in installments.

But is it always wiser?  It's certainly not unwise to pay when you owe people as soon as you're able.  Of course not.  I would argue, though, that it's not always beneficial to pay the whole amount of something up front.

There are a few main costs to paying cash (or cash equivalent) in full:

• More constrained cash flow.  Paying $10,000 cash for a car ends up costing less than borrowing the same amount at 6% for 48 months.  Nearly $1,300 less.  All well and good, but now you're out $10,000, instead of out only $234.85, which is the first month's payment.  If you had $65,000 in the bank before making this purchase, it's a no-brainer.  Lots of cash left.  But if you had only $12,000?  Probably a bit risky, because your reserves are way down now.
• Opportunity cost.  Paying $10,000 cash for a car means that, although you own the car free and clear, you no longer own the $10,000.  Is that a problem?  It is if you had another use for a large chunk of that money.
• Lost earnings on that money.  In today's environment that's utterly punishing to savers — 0.25%?  Anyone? Anyone? — this admittedly is a minor consideration for most people.  At some point, though, the interest rate on the loan gets low enough that there may be an investment out there that beats it.  In that case, it doesn't make a whole lot of sense not to take the loan!

Two times you should pay in installments

This isn't going to be an earth-shattering list.  (Heck, is it even considered a proper list if it has just two items?)  But these are the times I recommend paying in installments instead of all at once:

• When there is no cost savings for paying in full.  Or, when there is no extra cost for paying in installments.  If you don't get some kind of break for paying in full, why do it?  Our county's real estate taxes and personal property taxes are billed twice a year for precisely half of the total tax each time.  Paying it all in full just means that we're out the second half six months ahead of time, with no benefit to us.
• When the cost of the installments is acceptable in a reasonably thought-out context.  I'm such a weasel, I know. 🙂  But there could be any number of reasons why you'd pay in installments, even though it costs more.  Maybe things are going downhill fast for aging parents, and you'll need more cushion for the next year.  Or maybe you can cash in on a teaser rate that makes the cost of the installments barely noticeable.  But whatever the reason, if you've looked at the numbers, and understand the costs, then who am I (or anyone else) to judge?

Look at the context of what you're getting into.  Just like most everything else, really.