Zero Interest Loans: Why You Should Beware

Companies that offer zero-interest loans tout these vehicles as no-lose opportunities for borrowers. A major purchase that might otherwise require a lump-sum payment can be spread out over 12 months to several years, with 0% interest, thereby creating a more palatable cash flow situation. But such loans present pitfalls, including the temptation to make impulse purchases, the tendency to overspend, and exposure to exorbitant penalties for violating a loan's terms.

Key Takeaways

  • Zero-interest loans, where only the principal balance must be repaid, often lure buyers into impulsively buying cars, appliances, and other luxury goods.
  • These loans saddle borrowers with rigid monthly payment schedules and lock them into hard deadlines by which the entire balance must be repaid. 
  • Borrows who fail to honor the loan terms are subject to stiff penalties. 
  • These loans are typically only available to prospective buyers with FICO scores of 720 or higher.

Zero-Interest Loan Basics

As its name suggests, a zero-interest loan is one where only the principal balance must be repaid, provided that the borrower honors the rigid deadline by which the entire balance must be satisfied. Failure to comply with the deadline carries hefty penalties. Most notably, the lender may rescind the zero-percent clause and apply backdated interest to the loan.

A staple at car dealerships and electronics retailers, zero-interest loans are facilitated through third-party lenders, any not by the stores themselves. To qualify for these loans, borrowers generally must exhibit FICO scores of at least 720. In most cases, the zero-interest option is restricted to shorter-term loans of up to 24 months for retailers, or up to 36 months for car dealerships.

Zero-Interest Loans and Impulse Buying

Car dealerships routinely inundate the local radio airwaves with ads touting zero-interest loan promotions. Prospective buyers should only take the bait if they desperately need a new car, and they are financially positioned to purchase one. Unfortunately, such ads often tempt buyers into making impulsive buys, when it is impractical for them to do so.

It is not surprising that salespeople exploit zero-interest loan promotions to push customers toward more expensive purchases, in a concerted effort to boost their commission income. Some dealers use zero-interest deals as leverage during price negotiations. With such great financing offers, salespeople are often disinclined to come down on purchase price. Buyers should avoid overpaying just because of low-interest deals.

Zero-interest loans promotions may attract buyers who fail to qualify for such programs. In many cases, opportunistic salesmen steer such individuals towards loans that do, in fact, carry interest. After espying a shiny new car or a slick flat-screen TV, many customers agree to such loans, even if the terms are unfavorable.

Zero-Interest Loans and Overspending

Zero-interest loans entice buyers to overspend their hard-earned dollars on fancy new cars and other luxury items. Rather than buying a sensibly-priced used car for $20,000, a buyer may recklessly choose a new vehicle, with a $30,000 price-tag, reasoning that they would be paying $10,000 in interest anyway, were he not receiving such excellent loan terms.

Zero-Interest Loan Penalties and Fees

Although they may seem like a dream, zero-interest loans can become nightmares for borrowers who don't fully grasp the loan terms. Lenders are quick to cancel zero-interest provisions for customers who fall delinquent on just a single payment. This holds true for revolving debt, such as 0% annual percentage rate (APR) credit cards and installment debt, such as a car loan. Borrowers who opt for such deals should be mindful of the penalties for paying late or for exceeding the loan's stated terms.

Consumers may elevate their FICO scores by paying their utility and cell phone bills on time, and by keeping their credit card balances low.

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  1. Experian. "720 Credit Score: Is it Good or Bad?"

  2. Consumer Financial Protection Bureau. "Consumer Financial Protection Bureau Encourages Retail Credit Card Companies to Consider More Transparent Promotions."