When is Zero Interest Too Much?

You get them, I get them, the whole world gets them … those enticing offers for new credit cards that come with a few magic checks. The offer sounds even more seductive. Use the magic checks to pay off debts and put them on this new card, which will only charge zero interest for the next six months.

Zero interest offers are also popular in the world of electronics or when you buy furniture. Buy this item and put it on credit, and you’ll pay zero interest for one year.

But these offers may not be good for your financial health and well-being! Why not, you think, what’s lower than zero? Well, nothing, but you need to read the fine print.

Many such offers impose a very specific time limit. There is literally a moment when the offer wears off. At that point, you need to know what happens with any balance on the statement.

You see, many of these offers say that if you owe anything — even a penny — on the day the offer expires, you then owe all of the interest at a normal rate that you would have owed had you financed the entire purchase from day one.

Now every offer is different, so you have to do some investigation, but I personally know of a couple that are set up this way. Here’s how it works. Let’s say you go to the store and charge $5,000 worth of new furniture on a zero-interest program. The fine print says you have to pay it off in one year. You dutifully make payments. But then some stuff comes up and you skip a couple of months. The bills come in but they always cheerfully tell you that you don’t have to pay at all that month. It makes it seem like payment is optional. On the one-year anniversary of your loan, you still owe $600. You figure, what’s the big deal? You can pay a little interest on the $600.

Then you find that you get hit for the interest on the full amount. Let’s say the company was charging 22% (a lot of zero-interest offers come from places that have high normal rates of interest) annually. That’s $1,100 in interest for the $5,000. The next bill you get is going to be not for $600 or $600 and change … it will be for $1,700 ($1,100 in interest plus the $600). Interest will then rack up after that.

Now let’s say you were smart and you bought $5,000 worth of merchandise on a zero-interest loan set up like that and on the one-year anniversary of the loan, your balance was paid in full. You are done! And you’re also in the minority.

These credit offers are very smart in that they appeal to our overblown sense of financial self-confidence. Many people with a lot of debt figure they can pay things off easier and faster than they really can. Plus, the invoices that come in have a friendly, encouraging tone to them that urge you to relax and skip a few payments.

If you are very disciplined and don’t overdo it, you can use zero-interest loans to your advantage. The point is, they will end up costing you if you don’t have a very firm (and reasonable) exit strategy from the beginning.