Young Investor

Buying only what you can afford

B. Venkatesh | Updated on November 15, 2017 Published on January 14, 2012

In the current economic scenario, people are apprehensive about using credit cards for high-value purchases.



It is the festival season in several states in India. And with festivities, comes the urge to spend, using credit cards. But credit cards can lead us into a debt trap. Retailers in India can, hence, adopt the layaway just like their counterparts in the US did to help people spend for Christmas. What is layaway and why is it behaviourally optimal?

Suppose you purchase couple of high-end ACs through your credit card. You can pay the entire amount when your next card payment falls due. Or you can opt for minimum payment, but suffer high interest on the balance. Given the current economic condition, many people are apprehensive about using credit cards for high-value purchases. The fear stems from either loss of job or pay cut.

Enter the layaway. Think of this as instalment credit in reverse. In an instalment credit, you buy the product and pay over a period of time. In a layaway, the store sets aside the product for you. You first make a modest down payment and continue with periodic instalments. You take delivery of the product from the store only after the final instalment is paid. If you fail to pay the instalments, the store cancels your purchase and returns your money minus a fee. The layaway, thus, enables you to buy only products that you can afford.

Optimal behaviour

You can create your own plan to purchase high-value products. All you have to do is to sock some money into your savings account each month and buy the product when you have accumulated enough. For one, such a plan avoids the layaway fees. For another, you also earn interest on the amount! But such a plan may not be behaviourally optimal. Why?

You may be tempted to withdraw cash from the account and spend it for other purposes. Money committed to pay for layaway is focused spending. And unlike credit cards, it does not hurt your credit rating even if you default on your payments!

(The author is the founder of Navera Consulting. He can be reached at >enhancek@gmail.com)

Published on January 14, 2012

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