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How Much You Pay is More Important Than How You Pay

Several years ago my wife and I were buying a vehicle and while we were waiting, doing paperwork, and waiting some more (there was a lot of waiting), a different couple walked in the door and one the salespeople said to them, "It's great to see you. What kind of payment are you looking for?"

Wait? How is that relevant? 

Unfortunately tricks like this work on many of us, and that's why they do it.

how to pay and what you pay


When we go to buy something we enter into what's known as a transaction. These days this involves money in exchange for the thing we want, but it doesn't have to be that way. It used to be you could exchange your services for something you wanted, and even further back you would exchange something you had for something you want - just trading. 

This is important because the transaction is what matters. How you pay is not the transaction. If you want a widget and the owner of the widget wants to sell it to you for a certain price, you can enter into a transaction. It doesn't, or shouldn't, matter to the person with the widget whether you pay in cash or get a loan to pay him or her. Further, the cost of your loan (the interest rate) shouldn't matter to the seller, either.  

Payments Can Be Transactions

Separate from the transaction that gets us the widget that we want is how we pay for the widget. If we aren't paying with cash we can think of this as a transaction, as well. If I can't afford the cash to buy the widget (or if I prefer to pay with credit for any other reason), then I can borrow money from someone. This borrowing of money is a transaction. I need money and someone else (usually a bank) has it. They will let me use it and there is a cost, just like there's a cost for the widget. The cost of using the money is interest and I'll have to spell out how I intend to pay back the bank with interest. 

Separate Transactions From Payment Method

So now we see that with large ticket items that many people take out loans for, like autos, there are really two transactions at play. There is a prices for the auto that we need to decide on, but then there is a price for the loan. This is two separate transactions. 

In the competitive world of auto sales it's easy to try and confuse consumers by mixing up these two very different transactions. Instead of asking what is our budget for our car or how much car can we afford, they simply asked what monthly payment do they want. This is their way into spreading out the length of the loan so 1) the car dealer can get a higher prices, and 2) the bank can get more interest. Two of the three parties involved win, one loses...guess which one you are. 


Let's look at my example here. If we can afford $10,000 for a car and I plan to get a three-year car loan for that car I might get a $300 car payment. If I know that monthly payment and they get that out of me, they can tell me about how they (through their bank) can finance cars for five years, or seven. If I finance for five years I can get a $16,000 car and if I finance for seven years I can get a $22,000 car. Not only do I end up paying the dealer $6,000 or $12,000 more than I can afford, I pay much more in interest to the bank. 

Another way car dealers can use loans to distract us comes in the form of add-ons. When my wife and I bought our most recent car we were able to get a 0% loan, which meant we didn't have to take any money our of our savings to pay for it. When it got time to start selling us on premium stereos, fancy interior upgrades, undercoating, protection for this, and protection for that, the salesman said, "and since it's 0% it's a no brainer." Hmmm. Since I'm not paying interest it's a no brainer to spend $1,500 on cloth protector? Now, that's a very sleazy way to suggest that it's free. Again, they are mixing up the cost with the payment method. Another way to say this (I only wish I brought this up to him) is that "since you are paying in cash, it's a no brainer to buy the extra stuff." That doesn't make sense, but unfortunately many people don't know the different in those high pressure situations. 

I get plenty of junk mail. I often get mailers for furniture stores or jewelry stores with their promotion of the month. It almost never talks about an item that's on sale or discounted. However, it ALWAYS talks about how they have special financing so you can pay full prices for their stuff (and as we saw, probably pay more than you were willing to pay). 


Mixing the purchase price of the thing you want with the payment method is a very easy way for us to accidentally pay more than we hoped we would. If you read this and only take one thing away from it, it should be this - remember that the price you pay for something is WAY more important than how you pay for it...and they are separate decisions!

Working your purchases into your overall spending and savings plans. Make sure you can afford your purchases and that they match your values. Only then start to consider the most appropriate way to pay and you'll be on track toward good money health. 

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© 2018 Money Health Solutions, LLC



About the Author

Derek Hagen, CFA, CFP, FBS, CFT-I, CIPM is a speaker, writer, and coach specializing in financial psychology, meaning and valued living, resilience, and mindfulness.


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