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Taking advantage of zero-percent loan

Dear Dr. Don,
I can borrow $10,000 at zero percent for one year. Would it be good for me to pay off my car ($10,000) when after a year's time the loan would turn to 9.9 percent interest versus the 5.4 percent rate I have on the car loan now? Or would it be good to put it into savings to collect interest and pay the whole thing off when it became due? Is there a good scenario that would benefit me in some way to take advantage of the zero percent rate?
-- Becky Bounty

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Dear Becky,
With the targeted Fed Funds rate at 4 percent, up 3 percent since June of 2004, those zero-percent offers are getting pretty rare, and I can understand you wanting to capitalize on a year's free use of $10,000. Read the offer carefully to understand its terms, including any purchase requirements or repayment assumptions.

One late payment on this or any of your credit cards or other debt could be sufficient reason for the rate to change to a market rate, or worse. All of a sudden that zero-percent offer is charging you 10 percent or even 20 percent, and all your calculations of financial savings are blown out of the water.

If this is a balance transfer offer for a credit card, you may have some difficulty using the zero-percent financing to pay off your car or invest in a one-year CD. If it is a balance-transfer arrangement, don't forget to consider the balance transfer fee in your analysis.

You didn't say how long your car loan has to run, but if it is two years or more, then replacing a 5.4 percent loan with zero percent for one year and 9.9 percent for the second year really doesn't buy you all that much, especially since you'll be paying down the car loan over time versus facing a $10,000 balance a year from now. Before you pay off the car, make sure the car loan doesn't have a prepayment penalty.

If you're not trying to free up money in your monthly budget then I like the idea of borrowing the money and investing it. If things go wrong with the offer you can free up the funds and pay off the loan.

But these zero-percent offers tend to work best when you want to take a little holiday from paying interest and use the reduced interest expense as a way to pay down your outstanding debts as rapidly as possible. Using the car as an example, you pay off the car then put the car payment amount into the bank each month to pay down the loan at the end of the year. You've earned interest on the deposits and didn't pay interest on the loan.

So it's not just the use of the money for a year, it's what you're going to do with the newfound financial flexibility in your monthly spending plan that should determine whether it's a good idea to take advantage of this offer.

Bankrate.com's corrections policy-- Posted: Dec. 7, 2005
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