So, let’s paint the picture.. You have followed all the MoneyGeek tips; sorted your budget out, keeping an eye on your expenses and you have implemented all our money saving tips. You now have good positive cash flow and you want to enjoy all that hard money work. You are standing in your local retailer looking at the latest 80-inch LCD behemoth TV with a big smile on your face thinking how good that will look in the lounge room. The helpful sales person mentions that they are doing a great interest-free finance deal with 2 years interest-free for a small monthly account fee and no repayments for 2 years… what do you do?
Interest Free deals have been around for a while now, with the main two players being GE and HSBC. Not all retailers offer these types of finance arrangements however if used correctly, interest free deals can actually save you money!
How can interest free deals save me money?
This will be a rare occasion that the MoneyGeek will use complex terms and where interest free deals are concerned, there are two principals to consider; the opportunity cost of the transaction and the future value of your money. Each works a little differently depending on if you have the lump sum saved that you want to spend or if you don’t.
Huh? Ok, lets explain! For examples sake, the whiz bang TV that you want is $5,000. You have saved your $5,000 and you are begging the sales person to take your money. I call this the ‘lotto winnings mistake.’ A lump sum of money has a funny way of accumulating interest – why spend your $5,000 when you can invest and buy your TV on no-interest terms? The interest you will accumulate will be higher than the 0% interest you will pay! The same happens with the lotto – too many people win a million and spend it all (rather than investing the sum, taking the passive income stream and potentially keeping the capital). Most interest free financing options have a monthly account keeping fee, but even for smaller sums, the interest earned still outweighs this cost. Example;
You spend the $5,000 you saved to buy your TV. You now have your TV, but no money to earn interest.
You take the interest-free finance option which offers no repayments for 2 years. It costs $5 per month, which over 2 years costs a total of $120. This represents an effective interest rate of 1.2%. You place your $5,000 into 2 year Term Deposit at an interest rate of 3.8%. After 2 years (interest reinvestment after 12 months) you have earned a little over $380 in interest and you use the $5,000 at the end to pay the balance. As a result of structuring it in this manner, you have the TV and an extra $260! The higher the interest rate available, the more in your pocket!
In this example, the interest-free finance deal actually makes you $260! This is the opportunity cost – by spending your lump sum, it costs you the opportunity to use that money for something else.
When will this work?
This option will really work in two scenarios – the interest-free finance deal has ‘no repayments’ for the term, or you have the cash-flow to meet ongoing repayments.
TIP: You can work out what the effective interest rate of interest free financing is with the MoneyGeek’s calculator! (Download – MoneyGeek-Effective-Interest-Calculator.xlsx – 34.3Kb)
What about the future value of my money and this interest free finance deal?
So you don’t have the $5,000 saved yet, but you want to start saving for this super TV to buy in 12 months time. Do you save or do you buy now on an interest free deal?
If you saved for 12 months you would need to save $422 per month (if you accumulated interest at 3.8%). After 12 months you would have $5,169, earning around $105 interest. You would lose some of this interest to tax, lets say 30%. So after 12 months you have $5,137. This is lucky, as after 12 months, you would expect the cost of the TV to increase by around 2.5% – the $5,000 TV will be $5,125 in 12 months time.
What if you bought now on an interest free deal? You would buy the TV today at a cost of $5,000. If you used the $421 that you would have saved each month, to buy the TV on an interest free term, assuming a $5 per month account fee, you would pay the TV off in 12 months.
The outcome is basically the same! The MoneyGeek doesn’t advocate impulse purchases at the expenses of good disclsiplined saving, however if the situation warrants, sometimes it can be in your interest to buy now rather than later – especially if there is heavy item discounting to compliment the interest free deal.
Should I do it all the time?
Sounds good – whats the catch with interest free deals? There will be a point where you will run out of cash-flow so you cannot do it all the time, remember, every time you apply for credit, your credit record ticks an enquiry – the more enquiries the less attractive your credit record.
There are some potential wealth killers with this tip – discipline! These interest free guys would go broke quickly if everyone was an expert money geek. They make their money if people do not pay the balance within the time frame. The minimum payment they ask for each month is normally less than what is needed to pay it all off within the interest free time and many people rely on this to service the debt. If you go over the interest free term you are slugged with HIGH interest, typically in excess of 21%, sometimes closer to 30%! If you are going do to it, make sure you know what you need to pay to complete within the time frame and keep your disclipline!
TIP – Use the MoneyGeeks Interest Free Repayment Calculator to work out what you need to pay to avoid paying a nausea inducing level of interest! (Download – MoneyGeek Interest Free Repayment Calculator – 34.3Kb)
Interest Free deals can actually save you money but use wisely! The big tip – your monthly statements will show a reducing minimum repayment figure, if you want to avoid interest, maintain the same monthly minimum repayment that you worked out with our calculator and not only can you save money, you can get your dream purchase sooner rather than later!
Have you had success or failure with Interest Free Deals? Share your successes and disasters with other MoneyGeek’s below!
About the Author – The Money Geek
The Money Geek is the head money blogger for MoneyGeek.com.au. With over 8 years experience in the finance industry, the Money Geek provides information over a range of topics to help families Australia-wide improve their financial literacy to become their own geeks and take control of their financial future!