Companies that offer zero-interest loans present them as propositions in which the borrower cannot lose. A major purchase that might otherwise require a major cash outlay can be spread over 12 or 24 months for free, creating a much more palatable cash flow situation. However, there are several pitfalls with these loans, including a greater likelihood of making an impulse purchase, the tendency to overspend and major fees for exceeding the loan's term.
Zero-Interest Loan Basics
A zero-interest loan is exactly what it sounds like: a loan in which only the principal balance must be repaid, provided that the borrower complies with the terms of the deal. These terms typically include a rigid deadline by which the entire balance must be repaid. Exceeding this deadline not only carries a hefty penalty, but, in many cases, the lender rescinds the zero-percent clause and applies backdated interest to the loan.
Zero-interest loans are common at car dealerships and at retail stores that sell electronics and household appliances. The loans are offered through third-party lenders, not the stores themselves, and to qualify generally requires an excellent FICO score, such as 720 or above. In most cases, the zero-interest perk only comes with shorter-term loans, such as 24 months or less at a retail store or 36 months or less at a car dealership.
Zero-Interest Loans and Impulse Buying
Often when running promotions, car dealerships inundate local radio airwaves with ads touting zero-interest loans. Financing a new car at 0% interest rather than at a higher rate is a savvy decision, but only if the buyer actually needs a new car and is in a good financial position to purchase one. The problem is, these ads can be so enticing that buyers who should not be considering a new car descend on the lot and make impulse purchases.
Promotions for zero-interest loans attract many more buyers than those who actually qualify for such loans. The buyers who show up only to learn that their credit does not qualify them for the 0% rate still receive slick sales pitches designed to steer them into loans that do carry interest. Even if the terms are not favorable, it can be difficult to say no, particularly if the buyer has already drawn a mental image of driving off the lot in his new car or installing his new flat-screen TV.
Zero-Interest Loans and Overspending
Zero-interest loans provide a convenient excuse to spend more money on a new car or make a luxury purchase the buyer otherwise might not make. Instead of purchasing a perfectly fine $20,000 car, the buyer trades up to a $25,000 vehicle, rationalizing that he could be paying at least $5,000 in interest anyway, were he not receiving such excellent loan terms. Now his cash outlay is the same as with an interest-bearing loan, and he has a vehicle with only marginally better utility.
Salespeople take advantage of zero-interest loan promotions by using them to push customers into more expensive purchases that pay higher commissions. Additionally, some dealers use zero-interest deals as leverage during price negotiations. With the buyer receiving such a great deal on financing, often the salesperson is less likely to come down on the purchase price. Buyers should take caution that they do not use interest savings to justify overpaying.
Zero-Interest Loan Penalties and Fees
Zero-interest loans can seem like a dream, but they can become a nightmare quickly for borrowers who do not read the terms and understand them fully. Lenders are quick to cancel zero-interest provisions for noncompliance, sometimes for a transgression as minor as a single late payment. This goes for revolving debt, such as 0% annual percentage rate (APR) credit cards, and for installment debt, such as a car loan. Borrowers who take advantage of such deals should understand what the deadlines are as well as any fees or penalties for paying late or exceeding the loan's stated term.