Money for nothing?
The conventional wisdom of our grandparents' era was rooted in a simple financial philosophy: save before you buy and avoid credit at all costs. Such an old-fashioned approach stands in sharp contrast to contemporary behaviour, where an escalating sort of financial hedonism has left Australia with one of the highest levels of household debt in the world – a whopping 123% of GDP in the third quarter of 2015.
Whether it's credit card switches, car loans or consumer goods like appliances bought on interest-free plans, we can't seem to stop borrowing. But before you toast your latest purchase with a round of drinks charged to your no-interest credit card, take a leaf from your grandparents' book.
We take a look at:
Why is 0% interest on offer?
All financial loans are carefully crafted with the goal of reaping profit from you, not helping you get ahead in the world. So how do lenders pursue that overriding agenda using a 0% interest strategy?
To get the lowdown on what's really going on, we talked to Justine Davies, the finance editor of Canstar, who's seen her fair share of interest-free deals.
Canstar's website currently features 112 0% credit card balance transfer deals. Some of them may even be a smart move if you proceed with caution.
According to Davies, a better profit margin is probably a seller's main motivation for offering low or no interest deals. With zero interest deals, the sticker price is usually higher to begin with. Simply put, a car on offer with 0% interest finance will likely be priced higher than one on a regular finance plan.
"If a customer is relying on a loan to purchase the goods at all, then the customer is not in a strong negotiating position and the seller can charge a higher price," says Davies. "In the opposite scenario where the consumer is paying cash or has pre-arranged finance, they would have a greater ability to negotiate a lower price."
Businesses generally aren't in the habit of providing something for nothing – so do your research and stay smart.
"As a consumer, you need to work out how a business is making money from a 0% deal and then decide whether the benefit of the deal will outweigh the possible cost. There are ways to make the deal work but you need to be smart," says Davies.
Consumer goods and cars
Conditional loans can lock the buyer into buying at a higher price.
"For example, the buyer might only get the 0% loan if they agree to pay the full retail cost of a product – let's say a car bought at full retail price – with no room to negotiate. In this case, it could be that the buyer might be better off purchasing the car at a lower price using their own low-interest finance, a personal loan for example, or other strategies like a trade-in option," explains Davies.
Real cost of a loan
Because of clever marketing and spin, the real cost of a loan may not always be obvious at first glance.
"Be prepared to pay additional costs and fees which can really add up over the course of the loan. These fees can include things like a one-off application fee, admin fees, monthly account fees and penalty charges if payments are missed," Davies says.
In the excitement of the moment it's easy to forget that life doesn't always go to plan, particularly when it comes to money. That's important because economic ups and downs can affect your ability to repay the loan in the agreed time. If you're unable to do so, the punishing revert rate will kick in after the introductory period – far more than 0%. Interest-free periods are always limited, so that may be just what the seller is hoping for.
Is 0% financing really the best deal?
A no-interest loan may be tempting, but consider all your borrowing options to find the best deal.
For example, a car bought for a full retail price of $25,000, with an interest-free loan for five years and a $10 per month admin fee would cost $427 per month. That same car negotiated to $20,000, financed by a loan at 8% interest over five years, would cost just $406 per month. Or, if you got a 5% loan as a mortgage overdraft, the monthly cost on $20,000 would be $377.
0% interest vs an interest-bearing loan at a lower price
Retail price $25,000
|Interest on five-year loan
|Paying full price $25,000
|| $10/month admin fee
|Negotiated to $20,000
|Negotiated to $20,000
|| 5% (as a mortgage overdraft)
Tips when considering 0% finance
- Shop around before locking in a 0% finance deal. Ask yourself what price those goods would be for cash, how negotiable would that be, how badly do you need those items – and will they be obsolete before you've even paid them off?
- Ask yourself if it might be cheaper to make the purchase using an alternative strategy such as cash, a low-interest loan or refinancing.
- Read the fine print and always do the math before entering any formal agreement.
- Use loan calculators (ASIC has some good ones) to compare products.
- Remember, sometimes low interest loans can be cheaper than 0% deals.
CHOICE Head of Communications Tom Godfrey cautions consumers to look at the long-term costs, particularly when purchasing a car. "Although a 0% deal might sound like a steal, it's worth pushing the car dealer on the purchase price before you lock yourself in. Even if you miss out on the 0% offer, negotiating a reduced purchase price with a low interest rate loan might end up saving you in the long run."
0% credit card balance transfers
Australia's credit card debt currently stands at around $32 billion and it's climbing quickly. To service this debt, we're paying more than $5b a year in credit card debt interest. Clearly, credit cards play a significant part in the debt profile of the average Australian consumer.
"There is an absolute proliferation of 0% credit card debt transfer deals on the market at the moment," says Davies. "Currently on the canstar.com.au database there are 112 0% balance transfer deals, ranging from a balance transfer period of one month through to 24 months. It sounds great – but beware the traps."
What to watch out for
- Interest rates: One key trap with credit card debt is the purchase interest rate on the card. These can vary greatly so do your research before you sign up.
- Essentially, the 0% deal will only apply to the debt you transfer. If you use the new card for other purchases or cash advances, you'll be charged interest at whatever that card's standard interest rate is. That can be more than 21%, or even more in the case of a cash advance.
- Revert rate for balance transfers: Be aware that once the balance transfer offer period has expired, any remaining debt will accrue interest at the card's revert rate, which currently ranges from 7.99% to more than 21% – often as bad as the card you transferred from.
- Hidden fees: Check hidden charges like the transfer fee, which can be as high as 2.5% of the amount you're transferring (if you're transferring a few thousand dollars, that can deliver a nasty sting). Also, check the card's annual fee, any admin fees and late payment fees.
"Across the balance transfer deals assessed by Canstar, the annual fee can be as high as $700 while there are currently around 40 balance transfer deals with an annual fee of more than $100," Davies says.
How to make 0% credit card transfers work
If you have a credit card debt of $10,000 with a current interest rate of 16%, you could save about $880 in interest over the next 12 months (taking the reduction of the loan amount over time into account) by transferring the debt to a card with a 0% transfer rate for 12 months and no fee.
In addition, you could gain further by changing to a card where the interest rate on new purchases and the revert interest rate after the initial 0% period are both lower than the 16% you were previously paying.
- If you want to take advantage of a 0% balance transfer, look for the 'Holy Grail': A balance transfer deal that doesn't charge a transfer fee, has a low annual card fee and has a transfer period of at least 12 months. They do exist.
- For balance transfers, aim to pay off the amount you've transferred within the interest-free period. Any remaining debt will accrue interest at the card's revert rate, which can be 21% or worse.
- Remember, the 0% deal will only apply to the debt that you transfer. For new purchases, you'll be charged interest at whatever the card's standard rate is.
- Watch out for extra fees including transfer fees, annual fees and missed or late payment fees.
"Low- or no-interest rates can certainly be dangerous for consumers who don't take the time to work out the real cost – and I think that would apply to plenty of people," says Davies. "But don't overlook the benefits. 0% deals can absolutely work in your favour if you do your homework and learn to use them to your advantage."