subject: How Compound Interest Impacts Major Purchases [print this page] Let's look at how compound interest can affect our major purchases. We all like new things - new gadgets, new items for the house, and new cars. Sometimes we like them so much that we are willing to do whatever it takes to get them. This can include paying outrageous interest rates when we don't have the cash.
Marketing executives, sales associates and stores that we frequent know our tendencies and often take advantage of them. However, when we look at it in perspective, we may begin to feel differently about actually making that jump.
Store credit cards - a good or bad idea?
For example, let's say that we found a bedroom set that we absolutely love. The current cost of the whole room is $4,000.00. Let's also assume that the furniture store offered to finance our purchase over three years. We would only have to pay $157.00 a month, and we can have the furniture delivered today.
While $157.00 a month may not sound like a lot of damage to pay in exchange for having a new bedroom set, let's take this example further. Based on these numbers, the furniture store is financing us at 24% annual interest. Now that's ugly. What's worse, once we finish making our monthly payments in three years, we will have paid $8,012.00 for a $4,000.00 bedroom set. That's twice the original asking price!
Cash is better
It would be much better if we are able to pay cash rather than finance the purchase. We can create a plan to save the money over a specific period of time. Let's look at two options: saving for three years and saving that same monthly payment.
There are many options that we can choose to use to save this money. In this example, we will assume that we are saving in a vehicle that is earning 4% annual interest. This is higher interest than a bank savings account. If we were to save the money in a general bank savings account, then the money would not grow fast enough. We have to find another investment vehicle that we are comfortable with.
Option 1: Save over three years
If we wanted to save a fixed amount each month for three years, we can reach $4,000.00 by saving $105.00 each month. This is much less than the monthly payment that the furniture store required.
Option 2: Save the same monthly payment
If we were comfortable with the $157.00 monthly payment offered by the furniture store, then we can save that amount each month for 2 years to reach the goal of $4,000.00 goal. This option reduces the furniture store's payment plan by one year.
Neither option allows us take the bedroom set home right away, but we can save $4,000.00 in unnecessary interest simply by waiting until we can really afford it.
This concept can be applied any major purchase that we desire. Being disciplined enough to exercise patience and cut back on our need for instant gratification can save us thousands of dollars in interest.
by: Ozeme J Bonnette
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