We have all heard the zero percent financing cry for attention. “Buy this new car and get zero percent financing”. “Need a new TV? No problem! Finance with zero percent and no payments for six months.” These offers sound great. Why spend money now if I can borrow the cash at zero percent. The stock market makes more than zero percent so I should just have this money invested. I can’t lose.
The trap of zero percent financing is not in the actual money savings from the low-interest rate; it’s the act of buying itself. When most people go to the car dealership, they don’t have the cash to buy the vehicle outright. Instead, they plan to finance, and with zero percent financing, they can increase their buying limit.
Car dealerships are notorious for dealing only in payment amounts. Do you want that truck? It’s only $325 per month. The low monthly payment sounds better than “It’s only $40,000”, but they are the same thing. When a buyer comes in with a payment in mind, the salesman can increase the buying limit and put the buyer in a vehicle that is more costly because there is no interest payment.
So what is the problem? Few Americans have the money to afford a vehicle in cash. The comparison of what they can earn in the market and what they spend in interest is a moot point. The zero percent financing becomes justification to purchase a vehicle or item that they cannot afford right now.
If a buyer were going to purchase a car in cash and then decided to take the zero percent financing so that they could invest the purchase price in the market, then that would be a different story and proper use of zero percent financing. Zero percent financing works in their favor because they have already allocated the money for a vehicle purchase.
However, without having the cash now, zero percent financing only increases the buying limit and therefore increases the amount and length of the payment plan on a depreciating asset.
The zero percent trap is a standard issue. I know I have made this mistake before. I’ve gone to the store to buy a sensible item A in cash, but if I can get a more expensive item B that I can make zero percent interest payments on for a year, why not?
It’s times like this that a buyer should step back and have an honest “needs and wants” conversation with themselves. They should not only focus on the item details, but also the timing. Do they need a new living room set right now? Or could they wait one year and purchase it then when they have the full amount allocated for the purchase?
Navigate Rough Waters
As much as I recommend avoiding payments at all cost, regardless of interest rate, I know that this is something not everyone can or will want to follow. So to this group, be careful when making large purchases. Avoid budgeting your purchase by monthly payment and instead focus on the actual cost of the item. If you had to pay in cash right now, which option makes more sense?
If you are negotiating the purchase of a vehicle or costly item, completely ignore the salesman asking for a payment you’ll be comfortable with, focus on the bottom line cost of the vehicle including all taxes and fees.
The payment is just a derivative of this number. Remember that they can always make a payment work for you. They can extend the payment terms from three to five years and enable you to purchase a whole new level of car, even though you may not be able to afford it.
There are few purchases that you must make immediately. Most can wait until you have the cash in hand.
If you find yourself in a situation where you need to make payments, think about whether this purchase can wait or if you can make some adjustments to make things work until you have the full amount saved. Once the entire amount is ready for purchase, then decide whether to buy in cash or invest the money for zero percent financing. Starting with the purchase price in cash is how you should use zero percent financing should be used. Not as a way to increase buying limits for items you probably don’t need right now.