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Consumers Who Make Quick Finance Decisions Often Pay Higher Fees


Why Do Consumers Who Make Quick Finance Decisions Often Pay Higher Fees?

Finance decisions are often difficult to make because there are a lot of variables to considering during the decision making process. Let’s consider the following scenarios detailed below, associated fees and interest rates.

To finance your purchase using a home equity line of credit or a credit card:

If you have access to a home equity line of credit then using the line of credit has obvious advantages to using a credit card. First off, home equity lines of credit typically have interest rates around five or six percent or even lower in today’s market environment. Whereas most credit cards have interest rates above ten percent, and many credit card interest rates are above twenty-five percent. Another benefit to using a home equity line of credit to finance your purchase is that any interest paid on the line of credit is tax deductible. Let’s say for example you make a $10,000 purchase using your home equity line at a 5% interest rate. Your annual interest would be $10,000 * 5 percent = $500, but then you can deduct that interest on your tax return. If you are in the 20 percent marginal tax bracket you will be able to deduct approximately $500 * 20% = $100. So you are effectively only paying $500 – $100 = $400 in interest per year. In this example, even though we used a 5 percent interest rate for the home equity line of credit, the effective interest rate is only 4% ($400 interest after tax payment / $10,000 = 4%). Credit card interest is not tax deductible.

Looking past interest – even associated fees are generally higher on credit cards. For example, if you are late on a credit card payment you are typically charged a $20 to $30 late payment fee. Credit cards typically also charge an annual membership fee of $20 to $100. A home equity line of credit, on the other hand, usually does not charge late payment fees; however, may have a small annual service charge.

To finance your purchase using a loan from your 401K or a credit card:

There are other alternatives to using credit cards such as financing your purchase by taking a loan out from your 401K. Similar to home equity lines of credit, 401K loans have low interest rates typically between 3 to 4 percent and a small annual fee. The only drawback to taking a loan on your 401K is that when money is withdrawn from your account or mutual fund you no longer enjoy the benefits of a return on your investment. Additionally these loans will typically offer better rates and terms than other installment or unsecured lending options, but that does not mean that they are always the best financing option to consider.

Since there are many good alternatives to credit cards, consumers should only use credit cards as a last resort.

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