Beware of the Payment Trap.

One of the oldest tricks in the car dealership playbook is for the salesperson to lead potential customers into the Payment Trap. A customer comes on the lot, picks out a car, and takes it for a test drive. If they like it, the next question out of the salesman’s mouth is this: “What kind of monthly payment are you looking for?”

The customer thinks it over for a second, and says something like “I can probably do $250 or $300 a month.” Answering this simple question, they’ve just walked right into the trap. “We can definitely make that work,” the salesperson says. They go into the office, do some number crunching, and find a way to finance the purchase so that the customer has a monthly payment of around $300.

The average customer has no idea that they’ve been tricked, but the salesman has cleverly steered the negotiation away from the real value of the car, and walked the buyer into the payment trap. By setting up payment terms that the customer likes, the dealer has made them think that they’re getting a good deal; meanwhile, he’s charging a premium price for the car, much higher than what he would have charged a savvy negotiator. And the company stands to make another tidy sum from the high-interest financing deal that they arranged to get the customer into the payments they wanted.

This isn’t an article about buying cars, but the story above demonstrates the dangers of the Payment Trap. One of the most common misunderstandings in American personal finance is that debt is no big deal, as long as we can “make the payments.” On everything from cars to furniture, electronics and entertainment items, we buy more than we can afford, stretch the payments out over several years, and get to take the item home today. Since we’re fixated on the monthly payments, we’re distracted from the real value of the item, and miss the opportunity to negotiate (paying with cash can often bring the price down) or to shop around for a better deal. Plus, since we have to pay interest on the loan, the item ends up costing us even more than the advertised price.

The Payment Trap can be especially dangerous when it comes to credit cards. Many American consumers rationalize their credit card debt this way: “I have a balance on my credit cards, but it’s no big deal, because I can always afford to make the monthly payments.” This is an illusion. Sure, you can make the monthly payments, but on most credit cards, the minimum monthly payment is calculated by adding the new interest charges for the month to 1% of the balance on the account. That means that it if you only make the minimum payments, it could take 100 months (more than 8 years) to pay off the  balance of the card; during that time, you’ll also be paying interest on the balance, which can add many thousands of dollars to the true cost of the items you’ve bought. And if you continue using the card, adding more to the balance each month than what you pay off, you create a vicious cycle of debt and interest that you’ll never escape.

Thinking about big purchases in terms of the monthly payments causes us to pay too much for the product, and then we pay even more in interest. And while it may seem easier to work a “low monthly payment” into your budget, the extra money you’re shelling out by borrowing could be used to save, to give, to be a blessing to others, or simply to have fun. You could even use it to save for the next Big Shiny Thing that you’ll want to buy.

Remember, just because you can “afford the payments” doesn’t mean that you can afford the purchase. And it almost always means that you’re getting a bum deal in the proccess.

By the way, what’s the best way to avoid the Payment Trap when you visit the car dealership? Just respond with this simple, powerful answer: “I’ll be paying cash.”