Financing a major purchase: What you need to know

Some ways of paying for big purchases may be more cost-effective than others. You can save by using a budget, investing in the markets, and taking out various loans.

Video Transcript

- A major purchase by its nature is a variable expense. But it's important to recognize whether a big purchase is discretionary or not. When the refrigerator breaks, we need a new one immediately. But the 48-inch TV, that can wait.

Paying cash for everything is one way to avoid debt. Unfortunately, you may not have the necessary cash on hand when something demands immediate attention. So this is not always viable.

The first step in responsibly financing a major purchase is to establish a household budget to see how and where the planned purchase can fit into your overall financial picture. You will also need to examine the use of borrowed funds for financing a major purchase. If you don't have a high tolerance for risk, certificates of deposit or money market funds are good savings vehicles for major purchases. Because money market funds are highly liquid, they are also well-suited for your emergency fund.

Income investments are a reasonable alternative to money market funds, as they provide steady interest or dividend payments. When the time horizon for your planned major purchases long enough, growth-oriented investments might be more appropriate. They carry the potential for higher returns. But there is a higher risk that their value will drop during any given short period.

For homeowners, a home equity line of credit, also known as a HELOC, is a line of credit that uses your home as collateral. Based on the value of your home, your lender will approve a certain credit line. Once you are approved for the HELOC, you can draw from it whenever you want. Borrowers who need only a set amount rather than a revolving line of credit may find a second mortgage more attractive than a HELOC.

Many borrowers take advantage of credit cards or installment loans. Interest rates on credit cards and installment loans tend to be high, especially for credit cards. Making the minimum required payment each month means only a small portion will go towards the principal. For this reason, this is the least desirable way to finance a major purchase. Stay financially fit, friends.

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