How To Finance Your Purchase Using A Credit Facility

You need to make a purchase, you could use cash - or maybe it's too expensive...should you get a loan? Use a credit card? or a credit line?  Maybe go into overdraft?  

Let's start with some clarification...

A loan gives you a lump sum amount of regular principal and interest payments.  We called this a fixed payment.  

Credit cards/credit lines are revolving debts that you can pay off and use them again and only get charged interest on the amount you use - you can pay off the principle whenever you like. This is a variable payment as it depends on how many days are in the payment cycle (some months have more/less days than others) and how much that balance was for that time period

The 2 main differences between credit cards and credit lines is that credit cards usually give you some type of reward for using them and usually have a very high-interest rate but do allow you an interest-free grace period.  The grace period means that no interest is charged on the purchases that you make until after your payment is due. When you make your payment, if you did not pay the entire balance, interest will start to accumulate, based on how much you did not pay off, each day until you do pay it off - that interest gets added onto your minimum payment of next month. In comparison, the credit line accumulates interest the day that you use money from it.

With that being said, here's a handy chart to summarize:

 

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Deeper explanation and tips!

1.     Are you going to be able to pay this off in a month? - Always use the credit card and make sure your credit card rewards you in some way for making a purchase.  Get the points provided by your card and then pay it off with the cash or wait till the end of the month and pay it off with a credit line.  Even for big purchases that you plan to finance with a credit line due to it having a lower rate, USE THE CREDIT CARD.  You will have no interest till your due date and then used the credit line to pay off the card.  You can't do this with a loan because the loan will be used to make the purchase in most cases.

2.     Are you going to make a large purchase and it will need to be paid over several months or years?  Use a loan or a credit line, whichever has a smaller interest rate!  This saves you the most money.  Usually loans aren't offered for just one year and if they are, normally it's at a higher interest rate.  Common 1 year loans would be for RRSP's through a bank and those usually have a very low interest rate.

3.     The situation doesn't change much for more than a year.  Sometimes you have opportunities to get loans at 0%.  In those situations I would highly recommend taking the loan, since it does not cost you anything to make the payments over time.  This is often the case for vehicles.  What you can do, instead of paying $20,000 cash for the vehicle, take the loan and invest that cash.  Make the monthly payment and let that lump sum work for you.

4.  An overdraft allows you withdraw your bank account into the negative, this usually has a fee associated with it and the interest is ridiculously high - usually the same or higher than a credit card!  It is always better to pay with a credit card than with overdraft! The overdraft is best used as a safety net if you have forgotten about an automatic payment that is to come out of your bank account.

I hope this helps! Learning how to use your credit is a great way to save and get the most out of your money!

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