I'm looking at paying for hosting, and I have prepayment options available:

Prepayment for one year earns a 10% discount, and prepayment for two years earns a 15% discount.

Is it better to pay monthly, or take advantage of one of the prepayment discounts? I'm pretty sure the biggest prepayment is best, but a fellow user suggested he thought the one year was the best option. Are they on to to something?

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    What's your discount rate? Ie if you didn't prepay for hosting, what interest rate would your funds earn (alternatively, if you're carrying debt, how much interest are you paying on your debt?). – Dan Carroll Oct 30 '11 at 1:00
  • Having thought about it some more, that seems key. Never really sat down and asked myself "what's my discount rate". I have savings at 1 percent, and loans between 2-3 percent, but I could move more money into a Roth IRA at something closer to 7-10 percent expected value. – jldugger Oct 30 '11 at 1:04

If you know you'll be using the hosting for the full two years, then go for it!

The only reason not to take advantage of such discounts is if you have reason to believe you won't use the service for that long, or that you may wish to change service providers during that time frame. If this is a company you're never worked with, you may wish to pay month to month for a bit while you decide if you trust them enough to sign up for a contract.

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    +1 for will you be staying with them for the entire period. If you plan to stay with them for one year but for some reason decide to change providers after half a year, anything less than a 50% discount on the full year is a net loss for you. – user Oct 31 '11 at 9:59
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    Also consider if can you get a refund on the unused portion if you pay in advance but later cancel. Often no, but sometimes you can, for instance on insurance or magazine subscriptions. – poolie Nov 1 '11 at 5:06
  • In this case, they will, but they will refund it at the undiscounted rate. Seems fair. – jldugger Nov 1 '11 at 19:33

The one year is the better deal if they repeat the offer. It's close to a 20% ROI. Really? How so? Glad you asked. Consider, for 12 payments the average amount of time they have your money is 6 months. Better still, the average time you DON'T have it is that 6 months, as you'd start by having the $full, less each month to $0 at the end. So surely the 10% is on a lesser amount than the full sum. It's close to half, depending on whether the billing is at the beginning or end of month. The return to you is closer to 20%.

Edit - If you pay me $100/mo for 12 months, that's $1200. A 10% discount is closer to a 20% ROI. As the math is more like $120 (discount) / $600 (the average sum you are out for the year). This help clarify?

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  • Interesting. So if I had no savings but access to a 12 percent credit card, this might justify carrying a balance? – jldugger Oct 30 '11 at 3:27
  • Create a spreadsheet, and see if you borrow the money at 1%/mo how you'd come out ahead. At 18% it would come close. – JTP - Apologise to Monica Oct 30 '11 at 3:46
  • I follow all the rest (+1 for a good point) but the "10% is on about half" part doesn't really make any sense. It's as if you're saying the 10% discount is on half, instead of the implicit loan formed by the deal. – jprete Nov 1 '11 at 14:28
  • edited in a response above – JTP - Apologise to Monica Nov 1 '11 at 18:32

The part I had a problem wrapping my brain around was figuring in opportunity costs. If you have outside places to put money to earn higher rates of return (like paying down debt), electing for no discount could be optimal. I think the key is to recognize the payment structure has diminishing returns: the one year lump sum earns 10 percent, and the second earns you an additional 5 percent. When put succinctly like that it makes a lot of sense.

I haven't done the math, but for the moment, it seems like if your other investment options are in the 5-10 percent range that guy was right.

EDIT: I built a spreadsheet to verify this. It seems Joe is right, but only if your investment options are above ~12 percent. Under lower conditions, the 2 year deal is better. And above 20 percent and monthly option is better. An interesting paradox of behavioral finance...

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  • are you asking the question and answering yourself within an hour? Why? Missing rep? – littleadv Oct 30 '11 at 1:16
  • Setting the bar high for best answer maybe? I didn't realize I'd settle on a good analysis this quickly. Still room to improve I think. – jldugger Oct 30 '11 at 1:22
  • The deal as proposed looked like a standard offering. Taking the one year deal two years in a row is a better return than the two year deal. And then of course only if you don't have a guaranteed better than 19% return elsewhere (as one would have by paying off a 24% credit card, for example.) – JTP - Apologise to Monica Nov 1 '11 at 21:04
  • My spreadsheet disagrees. Did I calculate something wrong? – jldugger Nov 2 '11 at 18:39

I ran an excel spreadsheet assuming that you would deposit the entire amount, withdraw each monthly payment, and interest would be compounded monthly.

For the first deal, you would need to get a rate of 19% to break even. For the second deal, you would need 13%. to break even.

It's highly unlikely that you can find such an investment, So I'd take either one.

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