What’s the best way to protect yourself financially when you make a big purchase? How can you determine whether it’s best to pay in cash or take out a loan? Most people don’t make large purchases very often, so when the time comes to think about buying a new car or house, it can be overwhelming to figure out how to budget for it.
In the financial planning world, there are many different approaches to paying for large purchases. There are some financial experts out there who will tell you to never buy anything unless you can pay for it in cash. Others will tell you that taking out a loan is fine for some things (like a house), but not for other things (like a car).
With all this conflicting advice, it can be tough to figure out the best way to make a big purchase. Fortunately, it doesn’t have to be as difficult as it seems. By taking a little time to consider your personal situation, values, and goals, you can decide on the best way to approach your next big purchase.
Figure out your priorities
Before you head to the car dealership or start scrolling Zillow listings, take a minute to solidify your (and your partner’s) spending priorities. This step is especially important if you have several large purchases you’re considering.
For example, let’s say that you have a large home improvement project, like replacing the siding or installing a pool. But you also know that your car is becoming unreliable, and you’d like to take a big vacation soon.
Which purchase do you make first? Should you pay for one thing in cash and finance something else? The answers will depend on your priorities.
Evaluate all those large purchases you’re considering. Which one is more important to you and your family? Can you wait on one of them? Would you be risking physical, emotional, or financial consequences by waiting?
For example, you could probably wait a couple of summers before building a pool, but you would need to replace damaged siding as soon as possible. Putting your vacation off for a few months would probably be less risky than continuing to drive an unreliable vehicle. Once you know your priorities, you can make a plan for those large purchases.
Evaluate your financial situation
Your financial values aren’t the only things to consider before you make a big purchase. It’s also important to look at your financial situation as a whole. For example, if you are thinking of financing a purchase, you need to make sure the payments would fit into your monthly budget. Or if you’re thinking of paying up front, you must make sure you actually have the cash to spend.
But there are other aspects to consider as well. Think about the big picture. Do you have an emergency fund? Are you saving for retirement? Do you have life and disability insurance?
It’s important to make sure you have some safety nets in place. That’s not to say that you can’t buy a new car unless you have an emergency fund that could cover six months of expenses. But it’s safer to spend a large amount of money when you know that you’re financially protected if something unforeseen happens.
Look at all the financing options
The next step is figuring out exactly how you’re going to pay for this large purchase.
There may be lots of options to consider:
- Paying cash
- Financing the purchase (e.g., car loan)
- Refinancing your mortgage
- Borrowing against your home’s equity (e.g., home equity line of credit (HELOC))
These are some of the most common financing options, although there may be others.
Take the time to consider all the options and how they would affect your finances now and in the future. If you’re considering using some of your home’s equity to fund your purchase, compare the pros and cons of refinancing vs. getting a HELOC. If you’re thinking of paying in cash, make sure you feel comfortable with the amount of money you’d have left in case of an emergency.
Be pragmatic, not dogmatic
We’re not going to tell you that cash is always the best option. And we’re not going to say that going into debt is always bad. Taking such as black-and-white stance isn’t really helpful or realistic, especially in today’s unpredictable economy. Your money is supposed to work for you, not the other way around. What do you need your money to do for you in this situation?
Sometimes paying with cash just isn’t feasible. It might make more sense to finance a purchase, depending on the terms of the loan. The right financing option is the one that’s best for your unique situation.
Preparation reduces the stress of big purchases
Making a big purchase doesn’t have to be stressful. If you take the time to verify your priorities and look at all the financing options, you can make the choice that’s best for you and your family. Sometimes, it’s worth taking out a loan to buy something as soon as possible. In other cases, it might make more sense to save up and pay in cash. Your family’s needs, circumstances, and goals will determine which option is right for you.
Want more tips about making big purchases, building an emergency fund, or identifying your personal money values? Check out our brand-new podcast: Everyday Money with Hannah Moore! You’ll get practical advice from Everyday Money founder and Certified Financial Planner™ Hannah Moore.
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