I was sitting at a sandwich shop the other day, having a snack and cranking out more posts for the blog. A small group of what looked like coworkers was talking loudly at the next table about everything from the stock market to the weekend’s golf round.
At one point, the conversation turned to cars and the best models on the road today. One of the men in the group got very excited about a particular model and after skimming through all the benefits exclaimed:
“I’m thinking of buying the car even though I don’t need it! 0% interest for 6 years…what a great deal.”
It took everything I had to stay in my seat and keep my mouth shut. Here was someone who was otherwise probably a sensible, responsible human being getting sucked into a buying decision he knows he doesn’t want!
I have no business of telling other people how to waste their money. But you, my dear readers, I have a lot of faith in, and want to warn you about what you’re getting into.
I’ve driven down the road of 0% financing a few times myself, and I’m sure many of you have too, or at least have been tempted to. It sounds like such an awesome idea on paper—defer payments, get a “deal” with free financing, and spread out your purchase into multiple, “comfortable” payments.
For a society obsessed with instant gratification, the 0% pitch is like music to your ears—have what you want now, pay for it later, and don’t worry about “being in debt” because we won’t charge you any interest for 3 years! Yippee!
In reality, things don’t always go as planned. Life gets in the way, unexpected expenses arrive, income dries up, things break and need fixing, or many of the other pressures we face on the health of our money. And more often than not—we end up regretting buying the very things that were supposed to bring us so much pleasure.
There are a number of key issues that make 0% financing something I avoid at all costs:
#1: The accrued interest clause
Most people will never read the fine print of their card agreement, and pay dearly for it. 0% cards are usually set up in a way that allows the card issuer to “defer” interest until the end of the promotional term.
Translation: If you don’t pay the entire balance within the 0% “window” (6 months, 12 months, etc.), ALL of the interest that accrued over those months gets slapped onto the bill.
Yes, you read that correctly—if you finance $10,000 for 12 months and pay your bill diligently, but leave a $1 balance at the 13th month, you’re going to get hit. How much? With most 0% cards charging insane interest rates these days (think 20-30%), you’re talking about thousands of dollars in interest. I bet you didn’t sign up for that…
#2: The monthly payment paradox
Realtors, car dealers, and electronics stores know that you’re much more willing to buy something if it can be a manageable part of your monthly budget. That’s why the Mazda won’t be pitched as $20,000, but rather “only $249 a month.” It sounds much better, but it also screws up your ability to evaluate the deal.
The TV which you’re about to get suckered into buying is actually $2,000, something you would never spend out of pocket. But when the salesman makes you realize that over the next 24 months, that’s a miniscule $83 payment, he has you converted. After all, you can’t afford $2,000, but you can easily afford $83. Hook, line, and sinker.
What’s more—when you start adding all the small accessories and bonuses to the deal because “it’s only $2 more a month,” the bill starts to climb.
#3: Deals on things you don’t need
Like our sandwich shop friend, we’re all hard-wired to find the best value for our cash. In fact, the more frugal we get, the more we try to seek those hard-to-find opportunities. It feels good to find and close a deal because of “anchoring”—the concept of comparing what we got to what it normally costs. Anyone in retail knows how effective this is.
In the case of 0% financing, this kind of deal-seeking can back-fire. That’s because 0% financing is, in fact, a deal when you compare it to financing at any other rate. The costs of buying a car at 5 or 6 percent are astronomical—we pay thousands of dollars in interest over the life of the loan, something we wouldn’t have with a 0% loan.
#4: The time value of money
Time-value-of-money purists will also argue that you can make a couple of bucks by placing the money you would have spent on Day 1 on your purchase in any kind of investment and using the “free loan” as a way to save your capital. Technically speaking, that’s true. If you invest $1,000 today instead of paying for a TV, you could make about $14 in a high-yield savings account like Smarty Pig in the course of a year. But what are the costs?
- You assume that you will spend the time to open and maintain a savings account for an entire year to reap the benefits.
- You are still buying a TV. If you didn’t buy it, you could have $1,014 instead.
- You could save for the TV for a year, still earning the $14 and paying for it in cash.
On the other hand, if you have the cash in-hand, and are willing to hang on to it for the entire duration of the promotional period, some of my other points (see #5) don’t apply to you!
#5: Trying to predict the future
If you’ve struggled with debt at any time in your life, you’ve learned the fundamental difference between buying something with savings and buying it with credit. The first banks on income you’ve made in the past, the second tries to predict the future (sometimes very optimistically), or even ignore reality entirely.
When we buy a house, a car, or a TV on financing, we’re essentially assuming that we’ll be able to afford the payment we’re committing to today for the next X number of years (length of loan).
The perceived “flexibility” of a 0% interest card on something like a TV is also its downfall—we are much more concerned about paying fixed debt expenses like homes and cars and tend to defer paying for flexible bills like the electronic store card we opened last year. Then we hit point #1 and realize we got screwed…
What about things you’d buy anyway?
If, and only if, you are going to make a purchase on credit regardless of the financing, 0% makes sense. The best example is buying a car—if you’re financing it no matter what, getting a 0% loan will save you quite a bit of money.
Here’s the thing though—I would never pick a car based on the financing deals associated with it alone. Most of the time, the best financing incentives are designed to drive sales of higher-priced or poorly-selling models that I want nothing to do with. The 0% rate will save you next to nothing if your car payment is 30% higher, or your maintenance bill is much larger than you expected.
What Can You Do?
Here’s a quick plan of action to avoid getting pinned against the wall with these cards:
- Make note of any 0% financing deals you have outstanding today.
- Review the card agreements and understand the penalties if you don’t pay within the promotional period.
- Cancel these cards as soon as you’re done paying them off (they’re worth little after that point anyway), and commit to never opening one again.
- If you’re ever tempted to finance something at 0% again, pay yourself the amount first for 12 months and then decide if it’s still something you want.
- Repeat in your head: “There is nothing I can buy at 0% which I need to have today.” Believe it.
I’ve seen it with my own eyes—no matter how many times someone gets hurt by these deals, they’re bound to be tempted by them again. It’s going to take a lot of willpower, but I know you can do it. You’ve been warned!
Photo by irwandy