Cash or Credit?

Whenbuying a big-ticket item, do you knowwhen it’s best to pay up or pull out the plastic? Lindsay Gellman does.

So you’re planning a big purchase this year—maybe a new home, a car, new living-room furniture, sending Junior off to college. You’ve done your research. You know what you want and the price you want to pay.

Now the big question: “Cash or credit?”

Believe it or not, financial experts say there are no hard-and-fast rules. Your best payment option depends on your financial situation, whether the asset will appreciate in value and on available interest rates.

First, take stock of your personal finances, says Stephany Kirkpatrick, a certified financial planner and vice president of operations and financial advice at finance site LearnVest.com.

Evaluate your household income—do you have one or two sources? How consistent is your income? Are you saving enough for retirement? Are you carrying any revolving credit-card debt?

The less favorable your answers to these questions, Ms. Kirkpatrick says, the less sense such a major purchase currently makes for you—and the more trouble financing it could cause you down the line.

“Where financing really doesn’t make sense is when you’re actually buying something that’s out of reach or [beyond] your financial means,” she says.

It typically makes sense to finance an asset that will appreciate in value, such as a home or educational degree, says Greg McBride, chief financial analyst at Bankrate.com. The rationale is that the asset will eventually be worth more than its price tag plus the interest you paid, Ms. Kirkpatrick says.

“It’s illogical for most people to pay $500,000 cash [for a home] when they can take that same money and invest it and get a 6% or 7% rate of return,” she says.

Not all loans are created equal, however. Ms. Kirkpatrick strongly cautions the typical home buyer against taking out an interest-only loan, which she says is “often used as a bridge to buy a house that someone truly can’t afford.” In such an arrangement, she says, the bank owns your home, and you make regular payments on your loan interest only; this keeps the per-payment amount low. It can be a recipe for trouble because, while “money is flowing out the door” every month, this setup doesn’t allow you to make progress on owning the home. As a result, you don’t gain equity, she says. Instead, stick to a loan arrangement where you’re making regular payments on both principal and interest, she says.

As for what to avoid financ-

ing, conventional wisdom suggests it is unwise to finance assets that depreciate, such as a car, or consumables, like a vacation, groceries or everyday expenses, Mr. McBride says.

But the current climate of extremely low interest rates calls into question that conventional wisdom, especially when it comes to purchasing a car, he says.

“Rates are so low right now that it can actually make sense to finance the car purchase,” he says. “If you can finance a car at 2%, why not?” Over the course of a four- or five-year loan, he adds, you’d essentially be financing the purchase at the rate of inflation.

And Ms. Kirkpatrick points out that 0% financing is available on many “medium-ticket” purchases, like furniture or jewelry. But those rates are typically available only to those with top credit scores (around 720 or above), she says.

Even if you decide not to finance your purchase, think about whether you’d benefit from charging it to a credit card—and paying off the card immediately—rather than writing a check or handing over cash, financial experts say.

Credit-card policies vary, but there are typically advantages to charging a large purchase, these experts say.

“Anytime you can route [a large purchase] through the credit card, it is pretty appealing to do so,” says Michael Kitces, director of research at Pinnacle Advisory Group in Columbia, Md. In this case, “you’re simply using the card as a payment conduit so you can rack up points or miles along the way,” he says.

Furthermore, some credit cards offer built-in consumer protection for purchases you make with them. For example, if your card offers built-in travel insurance, you’d do well to charge your $10,000 honeymoon, Ms. Kirkpatrick says. Cash, on the other hand, doesn’t come with such protections, she says.

There are a few caveats to note when incurring large charges. Be careful not to max out your card such that the purchase disrupts your everyday cash flow, Mr. Kitces says. In other words: You don’t want your automated utility-bill payment to bounce because you’ve reached your credit limit, he says.

Financial advisers typically recommend you stick to using less than 30% of your available credit to maintain a strong credit score. So you’ll want to be mindful when charging a purchase that will put you over 30%, Ms. Kirkpatrick says.

You’ll also want to avoid placing a large charge on a card on which you’re already carrying a revolving balance, she says.

But as long as you’ve been making regular on-time payments, and you pay off the bigticket charge within the billing cycle your credit score shouldn’t take a significant hit.

Bankrate.com’s Mr. McBride agrees: “If you’ve got strong credit and you have enough cash in the bank to pay the bill at the end of the month, a shortterm blip is inconsequential,” he says.

There are certain scenarios where it makes more sense to pay cash or write a check than to charge the purchase to a card. For example, it is best to pay cash if there is a chance you might be able to negotiate on price—such as at an independent shop or dealer—Ms. Kirkpatrick says.

And some businesses or institutions might charge a creditcard-processing fee. So be sure that what you’re earning in miles or cash back is more than you’ll be charged, Mr. Kitces says. (Airline miles are worth about one cent each, he says.)

“If you’re paying several percent in a processing charge in order to do this, you’re not coming out ahead,” he says.