Interest Free Loans – Would a company ever lend you money for free? Sadly the short answer is no. I’ll explain in 10 minutes how interest-free finance products work and how you’re still being charged for it.
Interest Free Finance Periods
This is a pretty common one when shopping online, getting a quote for home renovations, purchasing white goods – things like that. Typically you’ll be offered 3 – 12 months Interest Free.
So how do you get caught with Interest Free Periods?
1. During the interest free period you’re going to be required to only make a modest principal repayment (i.e. no interest, just a payment that reduces your loan amount). However, at the end of the interest free period you will start getting charged rates usually between 19.99% – 29.99%. Now the vast majority of people will elect to make the minimum repayment during this interest free period. This means that at the end of the interest free period you’re stuck with a loan that isn’t too different to what it was 3-12 months ago. But you now you have a loan on a higher interest rate compared to if you just took out a normal personal loan. Damn.
Most people can’t resist the honeymoon rate! So savvier borrowers think (a) I’ll pay it off within the interest free period; or (b) refinance the debt at the end of the interest free period. The lender knows this could happen, but they also know that for most people this won’t happen. Life admin takes a back seat, unexpected expenses come up, or you realise the repayments are just too high to fully pay the loan off within such a short time frame, so you’re stuck paying 19.99% – 29.99% p.a. It sucks, and the lender loves it.
2. The merchant or service provider is paying for that interest free period you receive. This means that one of two things will often occur. 1) The merchant increases the price of any service it’s offering you interest free finance on, or 2) they charge you a transaction fee to help absorb the cost of you taking up the finance. Either way, you pay for it.
No Interest Ever Finance
Often seen when shopping online, getting home renovations done, installing solar panels etc. Basically, these products claim you will never pay interest on their loan, and technically this is true.
So how do they get you with No Interest Ever facilties?
1. Fees: The cost of the fees you are charged on No Interest Ever products add up. If you borrow $1,000 and pay, for example, a $6 monthly fee, you’re effectively paying an interest rate of 22% p.a. Ouch! This doesn’t include any establishment fee or transaction fee you may be charged. These providers often claim that you won’t be charged the fee if you clear the balance by the end of the month. Again, they know that most won’t be able to do this. After all, if you had a spare $1,000 you probably wouldn’t have taken out finance.
2. Inflated Purchase Price: Common when visiting a car yard to purchase a new car or doing home renovations. The 0% finance option means that there is no flexibility on negotiating a lower price for the goods or service, but most importantly the price of the goods or service has likely been increased to cover the cost of offering the 0% finance promotion. In the home improvement space this can be an increase of anywhere between 5% to 25%.
3. Hidden Fees: Look our for early prepayment fees, transaction processing fees. These add up to a lot over the term of a loan.
What do you do? If you think you can pay something off within a Interest Free period than that’s a great deal. Why? Well it is the cheapest bridging finance you could hope for. However, a simple, transparent, low rate loan, where you know for certain what you will be paying for might be a better option. This will result in you paying less interest or fees in the long run.
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