Lump sum or monthly payments?

Many insurance providers give you the option of paying off a policy term all at once, or in installments.  Paying off all at once is called a lump sum payment.  The case can be made for both making lump-sum payments, and for paying in monthly installments.

For example, let’s say that a homeowner’s insurance policy is $600 for the year.  The insurer would typically give the homeowner one of the following options:

  • Pay $600 in full, or pay $50 twelve times, with a $4 check processing fee each time.  In this case, the monthly payment plan would result in an extra $48 worth of fees.
  • Pay $50 twelve times, or get a 5% discount for paying in full.  Paying in full would save the homeowner $30 (5% of $600).

In each case, paying over time is more expensive than paying up front.

However, let’s say that the homeowner is trying to build an emergency fund.  Paying over time, even though it’s more expensive, would alleviate a cash flow crunch at the beginning.  Rather than drain $600 all at once, only $54 would be drained the first month.  This would allow the homeowner to build up an emergency fund faster.

Lump sum vs. monthly payments involves a cost-benefit analysis.  Do you need the money now, or can you wait until later?  Are you willing to do without money now in order to save more money later?  Whether this is a good deal or not depends on the amount of the lump sum, and how much it costs to pay over time.  $48 may be an acceptable cost, but $150 wouldn’t be.  $4 might be a no-brainer.

Posted in Budgeting Know-How.

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