A couple of years ago, I unfortunately dropped a large item of furniture on my laptop and broke the screen. After declaring it unrepairable, this meant one thing: I was in the market for a new laptop. I spent a while checking out the screen, memory, and battery life, weighing the pros and cons of Windows vs. Mac, and all the other choices that go into making the big decision. After settling on a laptop, I discovered I actually had one more big decision to make with my computer: should I pay upfront or finance it for 12 months at 0% interest?
Free Money?
While paying a year from now sounds like a no-brainer it turns out that this isn’t quite so simple. For one thing, the 0% is obviously just a teaser rate. if there’s any balance outstanding after the introductory period expires, you’ll pay the full interest rate on that. This can often be as much as 20% or more for these types of credit cards.
But it actually gets worse. If you purchase an appliance for $1,000 and pay half off over your 12-month period, you’ve got $500 left. But instead of accumulating interest from that point on, your credit card company will probably bill you for all the interest you accumulated during the introductory period. With a 20% interest rate, this comes out to an additional $100 that you owe on day 366.
Consider Your Credit Score
The hazards don’t end there. Financing your new computer or other appliance can have a negative impact on your credit score. Your credit score, as you may know, can affect the credit offers you receive on interest rates or loan amounts. Obviously the bigger your score the better! However, financing your purchase, even at 0%, has three different ways to drag down your score.
First, assuming that they set your credit limit as your purchase price, you are going to increase your credit utilization ratio. Suppose you have a credit card with a $1,000 limit and no balance, and you finance your new purchase for $1,000 as well. Your credit utilization ratio just jumped from 0% to 50% overnight. Banks and lending agencies are going to take notice and think you’re attempting to live beyond your means.
Second, and less well known, having relatively new credit accounts isn’t as good as having relatively old accounts. Any new account will pull down your average and your score. A bunch of new accounts at once could cause serious damage, although the hit to your score from one new account likely won’t bankrupt anyone anytime soon.
Another downfall that people can have when financing is what I call minimum-payment misery. It’s that moment when, after making your minimum payments for 12 months, you discover that you still owe the majority of the purchase price. When financing a $1,000 purchase, your minimum payments might be as low as $20, and my calculator informs me that $20 times 12 months is a lot less than $1,000. After one year, you would still owe $760. If you can pay it all off at that point, then it’s no problem–but be careful to set aside the cash you’ll need ahead of time.
Whether you can afford to pay beyond the minimum or not–do make sure to make the minimum payments! In many cases, your rate jumps immediately from 0% if you don’t make the minimum payments, and your cheap financing will then be for nothing. On the other hand, making your payments on time and in full is a good way to build your credit score up further, especially if you have little credit history to begin with.
The Pros Outweigh the Cons
On the other hand, there are definite benefits to financing–and unless you really are trying to live beyond your means, it’s almost certainly still a good idea to finance at zero percent interest. While you have to pay for it eventually, the bank is literally giving you free money for a year. Your best bet is to set aside the amount of cash you’ll need to pay off the balance, and put it in a CD or money market fund. This way you can earn a bit of interest over the year, and at the end you’ll have the cash already set aside!
Note that if you do put the money in a 12-month CD, you’ll have to make sure that the due-date for your financing is after your CD becomes available–otherwise you’ll face interest charges.
Overall, financing is a good option when done at 0% interest rates. Low interests rates are the market’s way of telling you that borrowing is more attractive than saving. If you have a big purchase to make why not take the market up on those low rates? Be careful to avoid the pitfalls we highlighted, and you’ll be one happy shopper!
Have you had any luck with 0% interest rate credit cards?
Tell us about it in the comments!
Why is FinancesOnline free?
Leave a comment!