Chances are that if you’ve ever shopped for a new appliance, furniture set, the latest cell phone, or just about any major purchase of more than $1,000, you might have been offered the opportunity to finance it with a 0% APR.
These types of deals can be very tempting since they quickly reduce a large expense into a series of smaller monthly payments. However, beneath their harmless-looking exterior could be a pool of quicksand that will quickly trap you and your finances.
So what’s behind these zero-percent financing deals and why do they seem to be everywhere? Here’s what you need to know and how you can avoid the zero percent financing trap.
What Is Zero-Percent Financing?
Zero-percent financing is when a merchant gives the buyer a credit line that temporarily has no interest charges. The 0% APR typically lasts between 6 and 60 months depending on the size and type of purchase. It should also be noted that the actual financing arrangement is done through a partner company and not the actual merchant.
For example, you might want to purchase several new pieces of furniture for your living room totaling $5,000. You don’t have that much money on hand today, so the merchant offers you the chance to finance the purchase for the next 60 months with a 0% APR. In doing so, that new living room set now becomes much more palatable at just $84 per month.
From the perspective of most buyers, zero percent financing seems like a no-brainer. Large purchases suddenly appear to become much more affordable. Plus, they’re a much better deal than taking out a personal loan or racking up high-interest debt on your everyday credit card. However, merchants aren’t doing this out of the kindness of their hearts.
Why Do Some Merchants Offer Zero-Percent Financing?
The main motivation for offering zero-percent financing is to drive more sales. For instance, Apple knows that most people won’t rush out to spend $1,000 or more all at once on the latest model of their iPhone. So to work around this, they enable each of the major carriers to offer customers the chance to break up those payments over 24 months. This results in millions of additional units being sold at the cost to the consumer of an extra $30 to $45 per month.
Credit card companies will also sometimes offer introductory promotions where new cardholders get 6 to 18 months of zero-interest financing. Even though the credit card isn’t collecting any interest charges, they will still make money off of something called interchange. Interchange is a fee to the merchant (usually 1 to 3%) associated with each transaction. Even though you’re not paying any interest, you’re still making purchases, and the credit card company profits from each one.
Why You Need to Be Careful
One of the more sinister ways that financial companies offering 0% APR deals make their money is by what happens when a buyer misses a payment. Though terms will vary, the agreement is usually that the full interest expenses that would have been charged suddenly become due. And that can be costly!
It helps to think of zero percent interest as having an evil twin – the regular higher interest rate that the financial company would have normally charged you. As you make your monthly payments, the interest you would have been charged builds up in the background.
If you make all of your payments, then you’ll never encounter this evil twin. However, miss one payment or go over the time allowed to repay the debt, and you’ll be slapped with ALL of those outrageous background interest charges.
The consequences can be very significant. There have been stories of consumers who’ve bought an appliance with a 12-month 0% APR. They made all of their payments on time except the last one and were hit with those nasty interest charges. If the standard APR was 25% and the original purchase was $2,000, that’s $500 in interest alone. Ouch!
This is exactly the business model of those infamous Buy Now Pay Later services like Affirm and Klarna that you’ll see partnered with sites like Amazon and Walmart. They make purchases seem artificially affordable by showing consumers the smaller monthly price. This is a mental trick that often results in the shopper buying more than they should.
Buy Now Pay Later companies can’t wait for the shopper to miss a payment. As soon as they do, daily interest and late fees get applied. This creates a downward spiral for the consumer that’s hard to be freed from.
How to Play It Safe with Zero Percent Financing
Despite all of the potential pitfalls built into zero-percent financing deals, they can be navigated safely as long as you act responsibly and take the following precautions.
- Read your agreement. As they always say, “The devil is in the details” – and financing offers are no exception. Read through the terms carefully and make sure you understand them well enough to explain them to another person. If anything at all is unclear, start asking questions.
- Know exactly how much you owe. Oftentimes zero percent financing offers don’t require a minimum monthly payment and leave that up to you, the consumer. For the best efficiency, divide the total balance by the number of months minus one that qualifies for 0% APR. I personally like to subtract one month just so that I pay my debt off a little early and have some built-in safety margin.
- Set up auto pay. Nearly every financial provider in the world will allow you to establish automatic payments. Take full advantage of them! The best case scenario is to designate that the payment takes place one to two weeks ahead of the due date so that you can ensure it went through without issue. That way if you have to react and make a manual payment, you’ve still got time!
- Check your account regularly. Never ever assume that all your payments are going through and that everything is working out fine. Periodically check your account and see for yourself that all of your payments have been properly applied and that no new erroneous charges have been applied.
Finally, the best strategy when it comes to zero-percent financing deals is to use them as sparingly as possible. Even though it can be tempting to buy some really cool stuff for a low monthly payment, resist the temptation. Reserve these types of purchases for emergencies you’re not prepared to handle – such as replacing a major appliance that all of a sudden stopped working.
For everything else, budget your income accordingly. Use a helpful app like Buxfer to keep track of your spending habits and cut down on frivolous purchases that aren’t needed. Usually, once you start paying attention to what you’re buying, you’ll do a better job of being disciplined and not spending so much. That will give you the funds you need to outright buy the things you want rather than having to rely on zero-percent financing deals.
Featured Image Credit: Unsplash
Buxfer Blog 