Monday, May 23, 2011

A Skill That You Should Add to Your Financial Toolkit

Recently, I was in the market for a new water softener. I made a call to a local company that I got out of the telephone book and proceeded to get all of the information I would need to discuss with my wife, so that we could jointly make an informed decision. Honestly, all I really wanted to know was “How long is it going to take to install?” and “How much is it going to cost me? “ Quickly, I got the information I needed -- it would take a full day to install and it will cost me $2895.00. I was about to thank the gentleman for the information and tell him that I will get back to him as soon as I discussed it with my wife, when he made me one of those offer-you-can’t-refuse deals.

He told me that if I set up the appointment right away I wouldn’t have to pay that $2895.00 right away. He said I could finance the appliance for $75.27 per month over six years. I am usually a pretty skeptical person when somebody offers me a deal that I think is too good to be true, but I must admit, $75 a month sounded much more attractive to me than immediately dropping a cool 3 grand. Since this seemed like such a great limited time offer I asked him to hold on a minute and that I’ll be right back.

I decided to check out the numbers for myself. So, I got out my financial calculator and calculated what $75.27 per month for 6 years would cost. I figured that that was going to cost me a total of $5419.44. So, I then subtracted the initial cost of $2895.00 from the total. Based on this calculation I’d be paying $2524.44 in interest if I went along with this deal. This information didn’t make a strong enough case for me to decide whether or not it was a good deal. I remembered when I bought a home, after taking into account the interest rate, it was estimated that by the end of the term I was going to have to end up paying around double the amount of the original purchase. But in the case of my house, the interest rate was pretty low, so it worked out to be a good deal anyways. Therefore, I decided I needed to figure out the interest rate this guy was going to charge me.

So, I took the preliminary steps to let the financial calculator know that payments will be made at the beginning of the year and that there will be 12 payment periods and compounding periods per year since the payments will be on a monthly basis. Then I let the calculator know that the present value of the appliance was $2895.00, the number of payments was 72 (6 years), the amount of the payments was $75.27 and the future value of the appliance was $0 (since I was going to pay it all off). After entering the information I hit the compute button and out popped the result: 24.33%!

I promptly took the salesperson off hold and asked, “So, you are charging 24.33% interest for financing?” The salesperson was pretty dumbfounded that I was able to calculate the interest rate as fast as I did and from the information that he gave me. I then said I’d call him back if I decided to go with them. In this case, I was prepared to make the payment up front, but I was almost swayed into making the wrong decision based on my initial emotional response. Even if I didn’t plan to make the full payment up front, by knowing the high costs associated with financing through this company, I would have taken a different route at getting the money – like applying for a lower cost loan somewhere else.

Remember that anything that sounds too good to be true, usually is. That is why it is important to keep your emotions in check and get all of the information before making a financial decision. Knowledge of how to properly use a financial calculator can be one more tool that you can add your toolkit that can give you the added confidence to know that you were not cheated and that you made the right financial decision. It worked for me!

How are you adding to your financial toolkit?

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