0% financing always sounds so attractive because you’re getting free money to borrow. Get it now and pay later with no penalties right? WRONG.
To illustrate, about 10 months ago we had to get a new a/c system since our old one had gone out and was irreplaceable. After shopping around, we finally settled on a company with the a/c unit we wanted and at the price of $6000. When it came time to sign the contract with the contractor, he mentioned that they offered 0% financing. As long as I sign the contract by the start of work, the contract was quite simple:
– We would first pay a $200 administrative fee
– We then would pay whatever we would like for the first 12 months
– As long as we paid everything in full within the first 12 months we would be fine. If not, then we would pay a penalty.
Despite having the money available to pay it, my wife and I wrestled with this decision quite a bit. At this point, the stock market was on fire and we could easily make a 10% gain. The idea of having to dig into our savings and then work back up to the $6,000 again was a drag. We knew we had the stability and discipline to pay $500 toward the 0% loan every month. To be quite frank, a 0% interest rate was really attractive to us.
When it came time to install the a/c unit, we ended up paying the unit in full upfront. The night before I had done more research into the contract. Remember the penalty if we didn’t pay in full by 2 years?
The penalty was as follows: We would have to pay 25% interest on the original $6000 regardless of how much we paid already. Additionally, we would pay 25% interest on the remaining principal moving forward until it was paid off. For the people who don’t do math very well. This meant that regardless of how much we paid off we would owe an additional $1,500 in interest if we didn’t pay off in time.
If owing $1,500 for not paying in full doesn’t scare anyone away, the research will. Research showed most people don’t pay off the loan before the penalty. Instead, Americans usually end up getting securing a second loan to avoid the penalty on the 0% loan. Credit bureaus see 0% loans as risky loans. Personal loans could possibly lower your credit score because it assumes risky behavior. All these led to me seeing the 0% loan as too much risk.
A quick note: There are 0% loans without penalties, but they are usually for people with excellent credit scores and very rare. 0% loans with penalties like the one I described are common.
For the average American, there should be very few situations where a 0% financing loan makes sense. As a rule of thumb, you should always decrease your future financial risk and 0% loans are a future risk. It is easy to be overconfident about your abilities to pay back a loan, but many things can change.
Take my wife and myself for example. At the time we bought the a/c unit the stock market was booming and the business I was working at had so many contracts coming in we were working 12 hour days. Since we bought the a/c unit, the stock market has been unstable. The company I worked at did not get one new contract for 5 months after the new year. To make things worse, they do not expect to win any large contracts any time soon. I left the company recently. Recently, 30% of the workforce was laid off due to budget cuts. Another 10-20% is expected in the coming months.
I use this as an illustration that even as disciplined spenders, we never could predict the stock market becoming unstable and my previous job essentially coming to a grinding halt. Your future is never guaranteed. Your only guarantee is what you have right now. For this reason, you should avoid risking your future. As for myself, I have the peace of mind that I can sleep at night without having to worry paying an additional $1,500 which is much more valuable.
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