Personal Finance Advice – The Perils of Buying on Store Credit
Perhaps the most underrated, yet important piece of personal financial advice that could be given to something is the importance of avoiding credit, in particular store credit. This is often charged at substantial interest rates with the promise of credit being given to anyone, no matter what their credit history. It is important to get a good grounding in the understanding of credit deals, before you can work out what the so called ‘deals’ in the shop actually entail you paying overall.
Credit, especially concerning the purchase of consumer durables such as kitchen appliances or entertainment systems, in stores is usually given as APR which stands for Annual Percentage Rate. This is a widely used and standardized format that can be used to compare offers from different lenders, and the provision of the APR for credit purchases was made a legal requirement in the US with the passing of the Truth in Lending Act. APR is surprisingly easy to implement as a measure; simply take the APR given, and that means for every $100 you are in debt to the creditor that year, you will pay the APR in interest costs.
To clarify, follow the example of a purchase of $1000 with an APR of 8% with the total being paid back over 10 years. This means that in the first year you will pay $80 in interest, as this represents $8 out of every $100 being borrowed. A slight complication now arises because, as you are paying off the loan, you will be effectively borrowing less each year. Assume year two you now owe $900 (having paid off $100 in year one) with the APR still at 8% – you will now pay $72 in interest this year, as you are only borrowing nine lots of $100 rather than ten, and nine multiplied by eight is 72.
The example above can be applied to a store credit situation, where APR can be 30% or higher for some stores. If you imagine buying a $3000 television on store credit at 30% APR, you will find in the first year, you will be paying $900 just in interest. This money doesn’t benefit you in any way; it simply goes to a financial institution that makes mega profits from simply letting you borrow money for a short period of time. If you are paying for this TV over three years (which means a repayment of $1000 each year plus the interest cost), you will have paid back a grand total of $4800, meaning that you have paid $1800 in interest. plus the initial $3000 cost of the TV.
The best alternative to this scenario is to ask one’s self, “Can I manage without this item, at least for the time being?” In the case of the TV, you could instead manage with the old one you have that still works, or consider buying a very small one (and hence very cheap) to do for the time being. You should then save up for the item you ultimately want by making regular payments into a savings account. Not only will this mean that you can eventually buy the item a lot cheaper (as you are saving a large chunk of interest costs), but it also means that you will earn a little bit of interest by putting your money into a savings account until you can afford the item. This effectively makes the item even cheaper, as you are increasing the amount of money you have towards the item without actually contributing more to the real capital balance.
The flaw in the situation is when you really cannot manage without something, such as an important kitchen appliance like a fridge or cooker. This is the time you will be tempted to walk into a store, desperate to get your hands on a necessity, and have to take the store credit offer, as you cannot afford the item you need. However, you really must consider the alternatives to this; it is possible to take out a personal loan from the bank to cover such situations for much lower rates of interest, with many being 10% or under. This works out to be a much lower repayment amount than buying on expensive store credit.
The major downside to this is that some of these loans will require some sort of collateral, which involves securing the loan against a valuable asset such as your house. This means if you default (cannot repay) your loan you may lose your asset, or (in the case of small default) be forced to sell your asset to liquefy its value.
The simple conclusion is not to buy on store credit if you can avoid it, and if you really are desperate, search around to look for good alternatives from high street banks; a personal loan might well be the best option. If you are ever swayed by the ownership of the flashiest new item for your living room, or get pressured into buying it by a salesperson’s slick talking, remember the example above, and think about how much of your money will be wasted going to financial institutions.