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Analyzing interest-free financing deals


Dear Steve,
Retailers are promoting six-months-same-as-cash (or even a year) for home furnishings, appliances and electronics. What do you see as the problem? Are there opportunities to make payments during the interest-free period? Is it inconvenient to pay down the debt until the interest period begins? I promise not to indulge, I'm just curious about the pitfalls as you see them. Also, the auto industry has these zero-percent financing deals for four or even five years. Are they problematic as well? Do the lenders ever renege and begin charging interest? Can they? Thanks for all your sound, thoughtful insights and advice. -- Linda

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Dear Linda,
Let's start with retail purchase promotions of no-interest financing for a set period. This type of financing works best if you have a plan to pay off the balance before the interest-free period ends. The problems begin if you still have a balance once it expires. What many consumers do not realize about this type of financing is that, often, interest is charged on the balance owed from the original purchase date, not from the date the interest-free period ends.

Here's an example: You buy a refrigerator for $1,500 in January with an agreement of six months' interest-free financing. You make monthly payments of $100 during the six months. On July 1, according to the agreement you signed, interest charges are assessed on the remaining balance of $900 from the date of purchase, Jan. 1. The interest charges at an average APR of 18 percent (this could be higher depending on who the dealer uses for financing) would total $81 giving you a balance of $981. If you continue to make a payment of $100 a month, it will take you 11 months to pay off the balance and you will have paid a total of $169.24 in interest charges.

A better way to take advantage of the interest-free financing using this example is to wait nine months and save the $100 a month payment you can afford to use as a down payment when purchasing the refrigerator. You can then plan to pay off the remaining balance of $600 before the interest free period ends and save the $169.24 in interest charges. You could then buy a microwave or other kitchen item with that money instead of losing it to interest charges or begin saving for your next large purchase.

To sum up; to take maximum advantage of the interest-free financing agreements, have a plan to pay off the balance before the interest-free period ends and since one size does not fit all, read and understand the deal before you sign.

Now on to zero-percent financing for car loans. No, the finance company can not start charging you interest as long as you are making your agreed upon monthly payments. Some things to keep in mind before jumping on the new-car zero-percent financing bandwagon:

  • You must have near-perfect credit to qualify for an interest-free loan. Despite all the hoopla about it, only about 15 percent of those buying cars end up with zero percent financing. Call the dealerships you are considering and ask what the lending criteria are for zero-percent financing. Check your credit report before shopping for a car and you will have some indication of whether you qualify.
  • Do not purchase more car than you can afford. If you can't afford the payment, the interest rate doesn't matter.
  • Make sure the dealer is not offering a better cash-back alternative incentive. Depending on the sale price of the car and your trade or down payment, a cash back deal may be more money in your pocket than what you would save in interest charges.
  • Be careful with extending a loan beyond five years. If you wish to sell or trade in the car in a couple of years, you may owe more than the car is worth. This is called being upside down in your loan.

Both of these financing opportunities can be a great help in allowing you to acquire things you need at a lower cost. But remember, they should fit into your plan for how you want to spend your money; not just allow you to fit into someone else's plan!


The Debt Adviser, Steve Bucci, is the president of Money Management International Financial Education Foundation. Visit MMI for additional debt advice or click here to ask a debt question.

-- Posted: Jan. 10, 2003




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