I received some interesting responses to last week’s article on hire purchase. One reader noted that his parents took out the majority of their stuff using hire purchase. Another suggested that hire purchase is popular because many banks do not lend the small amounts shown in the article. He also noted that sales staff are very effective in encouraging the use of hire purchase—they respond quickly and you do not need an appointment. They make it easy to buy those appliances and furniture.
He also suggested that the “typical middle-class customer is more interested in the affordability of the payment, being uneducated to understand the interest rate that is often quoted as add-on.” And he concluded that he hopes my article encourages consumers to make correct financial decisions.
First I want to point out that it is not true that banks don’t lend for the small amounts shown. My first loan with a bank was for $500. Now that was about 40 years ago. However, that first loan allowed me to build up a relationship with the bank. The bank and the bank officer then had a basis for assessing my credit worthiness. They had evidence in the form of consistent monthly payments towards my loan and the deposits of my monthly salary to support my credit application. I had established a track record.
A young security officer was considering whether to use hire-purchase to buy a much needed appliance for his mother. He could ‘afford’ to pay the instalment. I advised him to apply for a loan at one of our banks and to deposit the differential between what he would have paid on the hire purchase loan and the bank loan in his savings account. At the end of the two-year loan period he not only had the appliance for his mother, he had savings in the bank. In addition to the bank, note that you should consider credit unions as a source of loan finance.
So what kind of savings are we talking about? Let’s look at some of the examples I shared last week.
Living Room Suite
You will recall that one of the examples was the purchase of a living room suite. The cash price was $7,999. No down payment was required. The very ‘affordable’ weekly payment was only $109. As the reader noted, this was so very easy to obtain. No appointments were necessary and the sales clerk was super friendly.
I understand, I too have considered buying on hire purchase. However, let’s look at the alternative. Yes, I know, banks can be very intimidating, they can seem unapproachable. Maybe, just maybe, they want to be sure that you can pay back the loan so that they won’t have to provide for and eventually write-off bad debts. They want to make sure that they protect the hard earned savings of their depositors—the source of most of the funds used to make loans.
Why should you do the hard work to prove to the bank that you are credit worthy? As the example below shows, the monthly payment on a bank loan of $7,999 at an interest rate of 12 per cent is $265.68. This works out to be $3,188.16 for the year or $61.31 per week. When we compare this to the ‘affordable’ weekly hire purchase instalment, we realize that we are paying an additional $47.69 per week, 77.8 per cent more than we would have to pay to the bank or credit union. At the end of the three years you would have paid off for the furniture and have $7,439.47 in the bank, just $559.53 short of the original cost of the living room suite. This is why you should build your banking relationship.
Let’s look at another example. The cash price of the LG Refrigerator was $17,336.25 and the down payment required was $4,070. Therefore the loan amount was $13,266.25. This time the very “affordable” monthly payment was only $1,204.25. Again, the very courteous sales staff would make this easy. The monthly payment in this case on a bank loan of $13,266.25 at an interest rate of 12 per cent is $624.49, for a monthly saving of $579.76 or 48 per cent. This works out to be $13,914.28 over the two-year term of this loan. In other words, at the end of the two years you would have paid off for the fridge and have $13,914.28 in the bank, $688.03 more than the amount borrowed to buy it.
I hope that these examples clearly demonstrate that investing in building a relationship with your bank or credit union makes sense. It is time to deal with your fear of banks. They don’t bite and the interest expense incurred will be much lower than the amount you will pay on a hire purchase transaction. If you really want to borrow to buy that piece of furniture or that mega TV find the lender with the lowest interest costs—your bank or credit union.
Let me repeat what I said last week, fear of banks causes most of you to have very superficial relationships with them. Those superficial relationships result in you being underbanked and, as a result, you leave your ‘dumb money’ sitting in bank accounts earning very little. There is nothing to be ashamed about here. Most of us are underbanked. We do not take the time to understand and make wise investment decisions.
As I also noted, you should avoid the trap of instant gratification and the desire to borrow to pay for stuff you really don’t need. Any debt incurred to pay for stuff you don’t need is BAD DEBT, and bad debt is usually debt that won’t make money for you. In other words, if you used debt for consumer purchases, it’s bad debt. If you used debt to buy an asset that depreciates in value, that’s bad debt.
However, if you must, if you cannot wait and must have that appliance or piece of household furniture, please do not use hire purchase. You may think it’s “affordable” but it’s usually the most expensive option available. I urge you instead to do the hard work, save and buy later, failing that use your bank or credit union.
As usual, I look forward to your questions and comments. Please send them to me at email@example.com. Remember to be responsible, wear your mask and stay home if venturing outside is not critical. Be safe. Take good care.
Nigel Romano is a Partner at Business Coaching & Advisory Services and Moore Trinidad & Tobago, Chartered Accountants