When an unexpected expense comes up, should you take money out of savings, or put the expense on a credit card? Paying cash has many advantages over borrowing.
You have an expense that comes up in life. Your house needs a new roof. Your car craps out. You need a new furnace, or dental work. Should you borrow money to pay for it, or tap into your savings? The short answer is the latter, if you have the money. But let's discuss why.
The arguments for using a credit card are many, and most of them are specious:
1. You don't tap into savings, and thus still have that money for a "rainy day": Look outside, it's raining. What are you saving the money for, if not this?
2. While you may pay interest on a loan or credit card, you are earning interest on your savings: Chances are, your loan interest is going to be at least 5-15%, depending on whether you are getting a home equity loan or using a line of credit (and let's not even talk closing costs!) or using a credit card or higher-rate debt instrument. Chances are, your savings account is earning far less than this, and if you are invested in stocks, it is not guaranteed you are making more than this. And not paying interest is guaranteed savings!
3. I can pay off the amount over a short period of time, and thus not disrupt my savings plans: Savings are for spending, and incurring additional expenses in the form of interest payments isn't "preserving" your savings plan, but will likely disrupt it, as the excess costs force you to cut back on savings in the long run.
So what are the advantages of using savings to pay for such expenses? There are many:
1. Since you are paying cash, you are in the cat bird seat: If you are putting a roof on your house and paying cash, chances are, you'll get a better deal from the roofer. If you have to arrange financing for something, it takes up more time, and you are less likely to be offered the better bargains. For example, if you use a credit card, the merchant has to pay a 2-5% fee on the purchase. Many merchants will thus offer a discount for cash.
2. Since you pay cash, you will shop around more: Buying on credit tends to fuel the "monthly payment" mentality. As a result, you end up looking at things in terms of monthly payment, not the overall cost. So a huge increase in cash price comes out to "only $25 more per month" and you don't object. But when you are paying cash, you tend to notice these price hikes more, and are more astute about shopping price.
3. Since you pay cash, you pay no interest: This would seem like the #1 reason, and the most obvious, of course. If you borrow $10,000 to put on a new roof, and pay it off over a year 10% interest, you are going to pay nearly another $1000 in interest payments. So your $10,000 roof is now $11,000. What's not to like about saving $1000?
Of course, most people in the USA have no savings, and as a result, are forced to finance most purchases. And when you are behind the 8-ball, begging for money from the bank, you don't get the best deals. And this is why it is important to save up money - after-tax money - so you have savings to use for things like this. If you can save money, you can earn interest over time, and thus the $10,000 you need for your new roof might actually only cost you $9500, if you are earning 5% interest on your various investments. So not only do you save the $1000 in interest you would pay by borrowing that money, you save even more.
That $1500 delta in cost goes a long way toward rebuilding your savings buffer. Spending more to save money just makes no sense at all!
It is tempting to borrow money sometimes - so your carefully laid savings plans are not disrupted. But if you put aside money, you should have enough for your needs and not need to borrow. And if you find you need to borrow, then consider cutting back on your lifestyle, as the "need" to borrow money is a sure sign you are living beyond your means, and you need to cut back now, not later.