5 Questions to Ask Before a Big Purchase
When faced with a significant expense—whether it's a home purchase, medical bill, or another big expenditure—you have three primary ways (or some combination of the three) to cover the cost: pay with cash on hand, liquidate investments, or borrow.
These options—drawing down cash reserves, selling investments, and taking on new debt—all have consequences. To choose the one that's right for you, you'll want to think about how the purchase, your timing, and your approach to funding will affect your overall financial picture and goals.
Here are five questions to help you narrow in on a funding approach that makes sense for you.
1. Do I have the liquid cash to cover this expense?
If you have sufficient savings or maturing CDs or bonds, and the expense isn't too large, paying with liquid cash may be the most cost-effective strategy. But some transactions, such as buying a home or making a down payment on one, could require more than you can part with.
If you don't have quick access to cash or don't have sufficient cash reserves to cover it, you may want to consider other options, such as selling investments or shopping for loans.
2. Should I pull the money out of my investment portfolio?
If you've built up a healthy brokerage account, selling investments may be another way to cover the expense. But consider the consequences before you do. For one, selling investments usually triggers capital gains taxes, reducing the overall amount you walk away with. And if your gains are sizeable, the sale could even push you into a higher tax bracket.
Selling investments also reduces your portfolio's potential for growth and the benefits of compounding. If your portfolio is performing well, one option might be to leave your investments untouched and look for alternatives. Before liquidating investments, ask:
- What are the tax consequences of selling these assets?
- How could selling assets now affect my portfolio and financial goals long-term?
3. Could taking out a loan make sense?
Taking on new debt is often viewed as a last resort, but it can be a highly strategic move under the right circumstances.
When comparing loans, the interest rate should be a primary consideration, especially when making a sizable purchase like a home. A low interest rate can help ensure that the cost of borrowing doesn't outweigh the benefit. And of course, the lower the rate, the less you'll pay over the life of the loan.
Your income should also guide how much debt you're willing to take on. As a general guideline, try to keep home-related debt to less than 28% of your pre-tax income, and limit all forms of debt to 36%. When you exceed these thresholds, your risk of non-payment goes up. Delayed payments or missed payments can hurt your credit and reduce your access to loans in the future.
Finally, consider how quickly you can repay the loan—and weigh the total cost of borrowing (interest, plus any fees) against the cost of other funding options.
4. What types of loans should I consider?
If you have good credit, you should have plenty of cost-effective lending options without resorting to high-interest credit cards.
To cover a large expense for a short period (say, until you receive your work bonus or sell your home), bridge financing in the form of a securities-based line of credit (SBLOC) may be a solution. SBLOCs can be used for most purposes, except to purchase securities or pay off a margin loan. If purchasing securities is your goal, a margin loan is worth considering. Both SBLOCs and margin loans require you to pledge nonretirement investments, such as those held in a brokerage account, as collateral. Keep in mind that for both of these loans, you'll need to be approved and understand the risks, such as a potential collateral demand when there is a decline in the pledged amount due to market fluctuations.
If you own a home and need to fund a major repair or home remodel, you may be able to use your home as collateral to take out a home equity loan or home equity line of credit (HELOC). In most cases, you'll want to use these funds as a way to increase or preserve the value of your home.
For home buyers in need of a mortgage, the most common mortgages span 30 years, but shorter terms are often available. Interest rates can be fixed or variable, and the interest you pay is generally tax deductible as long as you can claim it as your primary or second home.
If these financing options aren't right for you, check with your bank about other loan types, such as a personal loan. Personal loans are often fixed rate loans and can be used for emergencies, like a medical crisis, major car repair, or unexpected tax bill.
5. Should I put the purchase on hold?
If these factors aren't working in your favor, and timing is flexible, it might make sense to hold off until conditions improve. For example, until interest rates go down or your cash flow goes up. If you're not sure about your next best steps, consult with a financial advisor, who can help you look at your overall financial picture to make a wise decision.
Read next
Big Expenses: 4 Borrowing Strategies to Consider
Or explore our strategic borrowing series.
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