Comparing payment methods | Consumer credit | Financial Literacy | Khan Academy

Let's say that we have decided to buy a television for $499, and we now need to think about how we are going to pay for this $499 television. We know we have many different options, and I'm presenting five of them to you in this video. We could pay with cash, debit, we could pay with a credit card, store credit, rent to own, or layaway, and the different terms are available.

So pause this video and think about in what scenarios would you pick different options, and then we will work through it together. All right, so let's think about the first scenario where you have money now. If you have, at least, let's say $500 in your bank account, if you have money now, well, then of course paying with cash or debit is an option. It's never a bad option.

Now, you could pay with the credit card, but in that scenario, I would encourage you to pay the balance off within the 28-day grace period so that you don't pay this almost 19% APR. That is very high interest that you want to avoid. So here I'm just going to put an asterisk here: pay off in grace period. We could think about the store credit the same way. The store credit is at six months interest-free financing, so you could view it as a six-month grace period.

I could check that, but once again, I would want to pay it off in that six months so that I don't start incurring that interest, which will probably be similar to that credit card interest. Now, I know myself psychologically; I like not having to worry about whether I'm paying these things on time. So, for me personally, I definitely would gravitate towards the cash or debit.

Now, some folks, the credit card might have some rewards that you get back. They don't mention them here, but that might be an incentive. But the reason they do that again is they hope that you don't pay in that grace period, and you start incurring this really, really high interest. Now, rent to own would not make sense if you have the money.

If we could see what this is costing you, $45 per month for 12 months, multiply that out—how much are you paying? Well, it turns out you're paying more than $500. $45 times 12, you are paying $540 here. So for the privilege of renting to own, you're paying an extra $41 over that 12 months.

So there is some interest in there just in terms of that extra money that you're paying; it's just not called interest. And then once again, layaway—you don't even get the television now, even though you want the television now, and you're paying a $5 setup fee.

So that's money that you wouldn't otherwise have to spend if you just paid it in cash or did some of the other options. So I would definitely go with one of these first three, probably the cash or debit. Now, if you don't have the money—so don't have money, don't have money now—I would try to stay away from that credit card because that's a really, really, really high interest rate.

I think if you think you can get that money within the next six months, this six-month interest-free financing from the store sounds pretty good. If within six months you can save up the money and you're going to get the TV now, then you can pay that down and pay it off in this interest-free period.

Once again, I'd be weary if you have to go beyond that. The rent to own is definitely worse than the store credit if you're able to pay it off within six months. If you think it'll take you 12 months or more to pay it off, then you have to think about what would be the interest on the store credit.

Then what is the interest that this roughly $40 that they're charging? Roughly $40 on roughly $500 over 12 months is roughly 8% interest, so it's still better than a credit card. So picking—if you don't have the money within the next six months—if you're talking 6 to 12 months, you have to know a little bit more about the interest on the store credit to decide between these two.

And then once again, if you don't have the money now, the store credit is still better than the layaway because you're not having to pay this $5, and you get the TV immediately. While in layaway, the TV just gets laid away someplace in the back of the store. No one else could buy it, but you're not going to see that TV until you pay for it, while with the store credit, you're going to get it immediately.

So my bias? If you have the money now, cash or debit; maybe credit card if you're disciplined about paying it off fast. And then if you can save up the money in the next six months, the store credit looks pretty good with the interest-free financing.