ARTICLES > Interest Free Loans - are they good or bad?
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Interest Free Loans - are they good or bad?
Here’s what happened to one client:  Andrew and Jenny were keen on a plasma TV but knew they did not have the money saved up to purchase one outright. Then, they heard a local department store had 24 months interest free terms on just the television they wanted. It was a little more expensive than in the shop next door but, because they could pay it off in instalments, they went down and purchased it - $3,600 spread over 24 months. They were asked to pay back a minimum of $30 a week ($120 a month).After 24 months they were shocked to discover that they still owed $720 and that this was to be repaid at 28% interest. That meant they owed $951 dollars, if they paid it back in a year – that’s about $80 a month for another entire year! What’s more, the television which was a little overpriced already was now going to cost them $4,951. Andrew and Jenny aren’t the first to get caught in this way and they won't be the last. A few things to be careful of if you purchase items on interest free terms:1] Be aware, it is a loan and, as with all loans, there must be some mechanism built into it so that the lender makes a profit. If we are not aware of that mechanism, we may be paying far more for the item than what it is really worth.2] As part of the credit contract you will usually be asked to make a minimum monthly repayment. This minimum repayment will not usually pay off your purchase within the interest free period. Make sure you do the calculation and pay the amount per month required to ensure you complete payment within the interest free period. 3] Beware also of set up fees and monthly charges. Interest free terms are offered by many department stores on purchases made with store credit cards, or with independent loan companies for up to 48 months. There are often establishment fees for these loans – usually around $25 – and may be a monthly transaction fee on top of that of around $3 a month. That means, if you purchase something on these terms for $1,000, and you pay it off within the interest free period, you are still paying $169 in fees – that is 16.9% interest spread over the four years. The item cost you $1,169, not $1,000. 4] What is not so common now is “Interest Deferred Terms.” People would often get caught out by this not realising that interest deferred is exactly what it says; the interest is deferred for a period but it still payable. So, let’s say someone took out a 24 month interest deferred loan for $1000 and paid off $750 within the two year interest free period. You could excuse them for believing they had $250 dollars to go plus the interest on that amount. But no – the interest was only deferred. They now owed the interest on the full $1,000. 5] Credit for interest free loans is usually provided by a finance company through the retail outlet. Some of these finance companies will send you a credit card as part of the credit contract. The assumption some people make is that, if you use this card, anything you purchase has a 24 month interest free period attached to it – not so. If you use this credit card outside any "interest free" promotion then interest and charges will be immediate and accrue in the same way as other credit cards. The only difference is that rates for credit cards issued by finance companies are usually higher than those offered by other types of lenders. 6] As will contracts of any kind, read the credit contract carefully. This type of credit may only be interest free if you pay the entire amount borrowed within the stated "interest free period". If you don't pay off the entire amount then interest may be charged from the day the credit was provided. Or it may include fees you didn’t know about. Or it may have some other clause that will impinge on your finances. So, Interest Free terms – great! But beware of the pitfalls. Many of the people we help who are struggling with debt began with the well-intentioned use of a store card. If this article was of interest to you, you might want to check out the article Extended Warranties, in the Resource Centre area of our website.
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