This post was inspired by a mistake made by my 23 year old son. This son, in fact.
His latest mistake concerned a guitar. Actually, it concerned another guitar. I think he has four or five of them. Honestly, I stopped counting a while back. And that's the problem. I thought I saw a new one floating around in his room, but he convinced me that it was an old one. Until I saw the bill.... The past due bill. For $500. Ooops!
Sure enough, I got the story out of him. He had bought it on a 12 months same as cash deal. He had great intentions of paying it off, but of course that never happened.
The sad thing is that he was living at home with us then and had plenty of money to have paid it off during that time. Now he has an apartment and a girlfriend, so it will be much harder for him to get it paid it off. Plus he's accrued a whopping $50-$75 in interest fees on the darn thing as a result of not working the 12 month same as cash deal properly. Dave Ramsay calls that a Stupid Tax, which I think is a great name for it.
Now let's back up and see how he could have done this better. It doesn't matter whether it's 90 days same as cash, six months same as cash, or one year - no interest. It's all the same basic concept. You buy a large ticket item - like a guitar and the store very kindly allows you an waiting period with no interest charges and no payments. For most people, that seems like a very attractive deal, and it can be a pretty good bargain if you work it right. However, if you don't have 100% of the charges paid by that date, they sock you with a whopping interest charge - typically 25% or more for all those months. Then they continue to charge you that huge interest charge until you get the whole balance paid off. Nice of them, isn't it?
Ideally, the first step would be to determine if you can afford the big ticket item? In this case, yes he could afford the new $500 guitar (although Mom didn't think he needed it!) although he wouldn't have been able to pay cash for it. The second step is to look very closely at the deal. What is the grace period, and how much is the ridiculous interest rate? What exactly is the final date before the interest charges kick in? We'll call that D-Day. My son still won't tell me the interest rate, but I'm suspecting it's at least 25% or more. And even worse, I'll guarantee that he doesn't actually know without looking it up. Most people don't bother to find out, and stores certainly aren't going to tell you, although they are required to post it a little more prominently on the paperwork.
Now you have two choices for step number three - you can look at the grace period and divide the total cost by that many months. In his case, that would have been $50 a month for ten months - easily affordable on his salary. You skip to step four - set it up on automatic payments and boom you're done. Just add a calendar reminder to make sure it is fully paid off by D-Day!
However, if the item is more expensive and you can't afford to pay it off within the grace period, you employ a different strategy for step three. You figure out how much you can afford to pay. Let's say it's $50 bucks a month and you set that up on automatic payments, so you make sure it gets paid even though you might not necessarily be seeing a bill for it. Then you set that calendar reminder about a month ahead of D-Day - and maybe even set two or three backup reminders for it, every week or so. This is not something you want to forget!
At that point, you start looking to move that remaining balance elsewhere. Let's say there's $500 remaining on the balance. Your best choice is to pay it off out of a savings account and then continue to pay that $50 a month for ten months back to your savings account. That's a very smart move and saves you probably $50 to $100 worth of interest.
However, if you don't have enough available in savings, you might want to move it to a low interest credit card, or even to your overdraft account, which probably carries a lower interest rate than the store. The important thing is that you have to pay off every cent of that balance BEFORE the final due date. If you are even one day late, blammo! You are going to get hit by that big fee. Think of it as a big boulder waiting to drop right on your wallet.
The best part is that when you do it like this, you get to sit back and laugh at that darn store. They gave you the free use of their money for up to a year thinking you were going to be like all those other poor saps and pay that Stupid Tax, but you outsmarted them and now you can laugh all the way to the bank!