Have you ever visited a retail store with the intention of ‘window shopping’, only to be enticed into buying something you don’t really need through an interest-free purchase program?
Whilst having up to five years interest-free to pay off a large purchase may sound too tempting to pass up, as with anything, always remember the age-tested dictum “buyer beware”. In the case of interest-free it’s not as simple as it sounds.
Here’s a common scenario…
Brad and Sharon went window-shopping and fell in love with a deluxe cream leather lounge suite. The price tag was $5,000. They hadn’t planned to spend that much money but the salesperson came to their rescue offering the chance to take the lounge now and pay it off over 48 months interest free.
He explained that there was a $30 set-up fee and a $3.00 per month account keeping fee, but absolutely no interest during the loan period.
Brad and Sharon had always been wary about these promotions – they knew there had to be a catch because businesses have to make a profit.
Where was the profit for the retailer?
It comes from the way the repayment reminder system is set up.
Some finance companies note on each statement that the minimum payment required may not be enough to pay off the loan during the interest-free period. However, the credit provider is not obligated to tell you that the interest-free period is ending (although some good providers do). It’s up to you to work out how much you need to pay every month to clear the debt during the promotion period and pay that amount – or more if you can.
In our example, Brad and Sharon would receive a bill for the minimum repayment due each month, probably around $75. Obviously this wouldn’t fully repay the $5,000 purchase price in 48 months and that’s when they would start to pay real interest – anything up to 30% per annum!
This means that the interest charged at the end of the promotion would be around $1 for every $3 of the amount outstanding. For instance, if you had a loan of $3,000, how would you feel about paying an extra $1,000 interest per year? That’s just not smart buying.
It’s not just interest
Also be careful when agreeing to long periods to pay off a relatively inexpensive item, eg. a $1,000 TV. The monthly account keeping fee will add up considerably over a longer period. Five years (60 months) at $3.00 is an extra $180 in fees, an extra 18% on a $1,000 purchase. Reducing the period of the loan will save you money on these fees.
The moral of this story
If you intend to buy using an interest-free arrangement, check your budget and make sure you can repay the entire purchase price (and fees) before the expiry of the interest-free period. If you do this, interest will be your friend. If you don’t, it will be a very expensive enemy.
For more handy financial planning tips, contact us at Leenane Templeton on 02 4926 2300