I was thinking this past week of ways to save money, and I realized lately how "odd" my primary strategy seems to other people. I'm in the process of paying off my credit cards, so when I need to make a large purchase I give myself a self-funded line of credit.
Basically, I give myself a loan. A loan that I pay back. Think of it as my checking account taking out a credit card from the Bank of My Savings Account. I make monthly payments, charge myself interest, and actually make money on my purchases.
Think about that. I make money when I buy things!
Here's a simplified example of how it works:
A Typical Model
Mark wants to buy a new computer. He takes a look at his finances - there's $50 in checking and $2000 in savings. Based on his income, he can afford payments of $100/month on the new machine without having to scrape by too much. But he doesn't want to give everything away, so he uses his Visa to buy the computer. He now has $50 in checking, $2000 in savings, and owes $2000 on his Visa.
Let's assume the Visa accrues interest at 12% APR and the saving account makes 2% in interest. Using those numbers, it will take 24 months (2 years) to pay off the credit card entirely if Mark pays $100 each month. But thanks to compound interest, Mark has paid a total of $2,242 over the two years (remember those annoying finance charges?).
Mark's $2000 computer ended up costing him $2,242. But that's OK! After two years he still has a fancy new laptop and his savings account (thanks to 2% interest) now has $2,078 in it. Not too bad!
My Atypical Model
Judy also wants to buy a new computer. She takes a look at her finances and, like Mark, has $50 in checking and $2000 in savings. She figures out that a $100/month payment will be affordable on her salary without breaking the bank. She's a savvy spender, so rather than taking out a loan from someone else or borrow against a credit card, she issues herself a self-funded line of credit against her savings account.
Let's assume that Judy charges herself 12% APR on the line of credit and her savings account makes 2% in interest. Using those numbers, it takes 24 months to pay off her line of credit paying $100 each month. Just like Mark, Judy will pay a total of $2,242 over the two years (remember, she's charging herself interest on the line of credit), but all of that is put into her savings where it earns additional interest at 2%!
Judy's $2000 computer ended up costing her $2000 because she didn't borrow money from anyone else. After two years, she has a fancy new laptop, and her savings account (thanks to the 12% financing and 2% interest) now has $2,284 in it.
See the difference?
Both people start out in the same boat - they want to spend $2000. Mark, by borrowing from someone else, pays that person finance charges. He's made $78 in interest on his savings, but paid an extra $242 in finance charges on the loan. In the end, he's lost $164 by using a credit card to make the purchase.
Judy, by borrowing money from herself, pays herself the finance charges. She's made a total of $284 on her savings, and hasn't paid anything extra to anyone else. In the end, she's made $284 by using a self-funded line of credit to make the purchase.
Which would you rather do? Buy a computer and lose money? Or buy a computer and make money?
If both Mark and Judy have more than $2000 in savings, they will earn more interest. Assuming they both have $12,000 in savings but still follow the above plan to buy $2000 computers, Mark will end up having earned $247 after you deduct finance payments from his earned interest. Judy will have earned $696 in interest and will have paid nothing in finance charges. Even taking additional savings into account, Judy ends up almost $450 richer than Mark when everything is said and done.