Why 0% Interest Isn’t Free Money

Newspaper with current interest rates

20 Jul Why 0% Interest Isn’t Free Money

Newspaper with current interest rates

No Interest Loans Still Cost You Plenty

It seems like every day I hear someone talking about how they got a great deal on something because they got 0% financing. 0% means it’s free money, right? Well, it sounds like it’s free if you’re used to thinking only in terms of interest rates.

But the truth is it’s still costing you money. A lot of people get into financial trouble by falling for these marketing gimmicks. Here are a few reasons why you should avoid using “free” loans to make purchases.

“Free” Loans Still Restrict Cash Flow

I personally stopped worrying about interest rates a long time ago when I resolved to be debt free. I realized if I couldn’t pay cash for it I probably shouldn’t buy it. So now I think in terms of available cash flow. If I buy something with an interest free loan, it’s still costing me because I still have to make payments on it to pay the money back.
That means my cash is tied up for a specific period of time.

I don’t like having my cash tied up and locked into payments. If I decide after six months that I don’t like the item, I can’t do something else with my money because it’s contractually obligated to pay off my “free” loan. That stinks.

Plus, if I’m only looking at the monthly payments when I buy, I might be tempted to spend more than the original total I had in mind. For example, if I shop for a $5,000 car and I only look at the payments, I might get suckered into a longer loan term with lower payments on a $6,000 car. Then I’d be stretching the payments out longer on something that’s losing value. Not too smart.

Opportunity Costs of Having it Now

There’s no such thing as free money. There’s an opportunity cost in everything we do. 0% sounds like a good deal but it’s not free. Tying up your money in a 0% loan means you’re losing the opportunity to earn 12% (or whatever interest rate is appropriate to your investing style) by investing it. Even if you take a lot of time to compare credit cards and maybe end up with 0% on a balance transfer, at the very least you’re giving up the opportunity to do something else with the money. Not to mention there’s usually a term limit on the 0% interest before the rate shoots back up.

Instead of thinking in terms of what payments I can afford, I think in terms of how much cash I can pay for the whole thing. If I save up the cash to buy something, I’m not tying up my cash flow at all. I still have cash in the bank until the moment I actually make the purchase. I have the ability to change my mind before I buy, and I can do something else with the cash. I’ll also make sure I don’t overspend on the item because I have the cash I need to buy the item.

Depreciation is Like Paying Interest

A zero percent loan also costs money through depreciation. Even though I’m buying something at zero percent interest I’m still losing money unless it’s an investment that appreciates. For everything else I’m losing money because the very minute I bring it home it becomes a used item and therefore is worth less than the retail price.

For autos especially, which lose upwards of 50% of their value in the first four to five years, I’m paying a pretty heavy effective interest rate through depreciation even though I’m borrowing money “interest-free. Appliances, electronics, tools and other household consume goods are the same way. They all lose value once they’ve been used once or twice.

90 Days Isn’t the Same as Cash

As I mentioned above, when you think about what you can afford for a monthly payment you’re really backing yourself into paying a higher price for an item than if you had payed cash. Think about it. If you walk into the furniture or appliance store and take the 90 days same as cash bait, they’re going to take the retail price and break it into three monthly payments. It may be a zero interest loan but they’re certainly not going to give you a deal on the price.

After all, why would they? They are in business to make money and they don’t make money by cutting deals to people who may or may not pay the balance on time. Since they’re taking a risk by extending you credit they want something in exchange for the risk. That something is called full retail price.

Now, if you walk into the store with a stack of $100 bills and offer to pay cash for the item, do you think you’ll get a bit of a discount off of retail price? You bet you will. If they don’t give you a better price when you wave the green under their noses, you can be sure their competitor down the street will. 90 days is not the same as cash.

No Interest, No Payments for 12 Months!

Oh, boy does this get a lot of people into trouble. What a tempting offer. You can take it home today and not have to worry about a thing for a whole year. Who wouldn’t jump at the chance to use someone else’s money for 12 months?

I wouldn’t. Everyone goes into these deals with the intention of putting away the cash each month to pay off the balance in full when the loan comes due in 12 months. That’s what sophisticated, money-savvy people do, right? They use other people’s money to get ahead with their finances (or so I’m told). By borrowing at 0% interest, they can invest the difference and come out ahead.

It’s a great concept but unfortunately nobody actually saves the money to pay it off. The loan becomes one of those, “we need to start saving for this” back burner projects. The next thing you know, it’s been a full year and you managed to save exactly nothing.

Now you’ve got payments due at a not-so-friendly interest rate on something that’s been depreciating for a year. So a year later you’re paying off a “free” loan with interest on something worth less than what you owe on it. How smart is that?

What do you think? Are you really getting ahead with no-interest loans? Leave a comment below. I’d love to know what you think!

  • Jeff Ehrlich
    Posted at 13:21h, 27 August

    Well written article and I concur that folks need to be working on getting out of debt and saving for the big ticket items. We purchased that necessity (pool table) 90 days same as cash and had other emergencies come up and I thought I would play pool every day – Not so true.. Maybe it was a man thing????


    • Matt Wegner
      Posted at 15:38h, 29 August

      I don’t think it’s necessarily a man thing Jeff, except that men have a tendency to do it with bigger, more expensive items. In our house we have bikes that we knew we would ride every day and a treadmill we swore wouldn’t collect any dust… Both mutual decisions.

  • Joshua Rodriguez
    Posted at 16:37h, 03 April

    Matt, big Koodos! I really loved this article. It’s rare that the opportunity costs associated with 0% loans are even mentioned let alone talked about in such great detail. Thanks for the incredible read!

    • Matt Wegner
      Posted at 18:15h, 03 April

      Thanks, Joshua! I don’t think opportunity costs are talked about enough in general, let alone in terms of low- or no-interest rate loans. It’s an important thing for consumers to remember when they sign up for all those payments.