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Clever Credit or Clever Catch

We are on the verge of the silly season, and I don’t just mean in terms of Christmas parties and festive activities. This season also applies to high levels of spending that occur throughout the months of November to January. During this time, consumers will be bombarded with offers of easy credit. Promotional interest free finance is extremely tempting and appealing given this particularly tight time of the year.

After all, you can effectively enter a retail store with proof of identity and clock anywhere up to $5,000 in a two year interest free, buy now, pay later deal. Want that brand new plasma, a new lounge setting, or perhaps you need to furnish a nursery? No problem, there’s nothing to pay for another 48 months. If used correctly interest free finance is a wonderful tool to purchase the 'big ticket' items that are difficult to purchase upfront. If you pay off the amount you owe before the interest-free period expires an interest-free deal can prove to be very cost-effective.

However, while it is easy to gain interest free finance, it is just as easy to get into serious financial trouble if you don’t use these offers to your advantage and lack discipline. Let’s take a look how you can avoid buying into a financial disaster.

Are you making the purchase because the item is simply on sale, or are you making the purchase because you desperately need the product; perhaps the fridge is on its last legs and you have found a real bargain? Recognise whether the purchase is a need or a want.

There is nothing wrong with accepting an interest free offer. However you need to know what you’re doing, do your research and look for any hidden catches before you sign your life away. There is no such thing as a free lunch. Take the perspective of the retailer, they are in the business of making money, you rest assure they will have factored the cost of providing the interest free finance into the cost of the goods. Rather than readily signing up, take the time to shop around. Is the product actually cheaper somewhere else, because they don’t offer interest free terms. If so could you secure cheaper finance, such as a personal loan?

Simon Beckett, general manager retail solutions, GE Money provides this valuable advice. “Right up front understand the terms and conditions of what you are signing up for, and be really sure you comprehend the affect these could have on your own personal situation.”

 Simon further advises consumers to make sure all fees and terms are fully disclosed. “It is important to draw up a budget,” Simon says. “Some consumers misuse interest free finance because they could never afford the finance to start with. Make sure you can afford to make continual repayments.”

If used correctly Simon says interest free credit can be the cheapest form of credit in the market place. Work out the real cost of the offer. Some shoppers are disappointed to find once they total up the repayments and finance costs, they have actually paid more for the item and it’s not the bargain they thought they had. And read the fine print, even though you may be signing up for an interest free deal, there may be hidden charges, like accounting fees or establishment costs.

You need to understand the offer; it is easy to confuse an interest free offer with a consumer lease. A consumer lease is a form of finance also provided by retail outlets. Stores selling more expensive consumer goods like furniture, TVs, computers, and whitegoods tend to offer consumer lease finance. This type of finance allows you to lease the items over time rather than buying them outright. A consumer lease can prove to be far more expensive, because essentially you do not own the item at the end of the payments.  You could be required to pay the residual value of the item before you can claim ownership. Simon advises consumers to understand the type of finance they are taking on.

There are two types he explains: ‘buy now, pay later’ which doesn’t require payment until end of the interest free period and ‘interest free schemes’ that require a minimum monthly payment. “You must make sure you can afford minimum payment and pay it,” Simon says. “When people do go wrong with interest free finance, it’s usually because they don’t do their budget up front, it is critical that you are able to continue to make repayments in the interest free period.”

You need to be aware of the penalties should you not pay the total balance before the expiry date. Some finance companies will not warn of the looming d-day, instead they will slap you with an interest charge of up to 20 to 30 per cent. In some cases this is based on the total amount borrowed, not the balance owing. Even if you have $2 outstanding at end of the term, you risk triggering off an interest charge on the entire amount, compounded over the total duration the finance was provided, although Simon stresses that GE Money applies interest only to the balance owing. It is a good idea, if you sign up for store credit to make sure you are well aware of the final date for payment and try and pay a little more than the required amount each month, this way you can be confident you will not fall into the interest trap. Many borrowers find it difficult to escape once they are trapped by the higher interest rate.
It pays to read the fine print. Some interest free finance leases have hidden clauses, such as miss one minimum monthly payment and you can invoke the immediate calculation of interest on the amount borrowed. At 30% this could really hurt.

In a hypothetical scenario, Cannex compared buying furniture or a home theatre package worth $10,000 using store finance of 18 months interest free against using a personal loan at 10 per cent over three years. Through a personal loan, regular monthly repayments will be $322 to ensure that the debt is completely paid out after three years, total cost $11,616. In terms of using store finance with 18-months interest-free, where the consumer has only managed to pay back half of the debt, the remaining $5,000 will accrue interest at 28 per cent. After a further 18 months paying off what’s owed, you will have very nearly caught up to the personal loan total, diminishing the savings benefit you signed up for in the first place. If the couple elected not to pay anything during the first 18-months interest free period, their monthly repayments would double to $686 for the next 18 months for a total $12,361.  In a worse case scenario, the consumer pays nothing during the interest-free period and then pays only the minimum of 3 per cent of the balance each month. At the end of the three-year period they would still owe over $8,800. Keep paying the minimum and the loan will last for 31 years, costing a whopping $41,608. You can see the perils of paying only the minimum monthly amount on any loan, let alone one charging up to 28 per cent interest. Source Cannex, www.cannex.com.au - Report No 7, July 2008

When you sign up for an interest free offer, most credit providers will issue you with a credit card. It is just like any other card and can be used for other purchases. Some credit providers will issue store credit, with the underlying intention of increasing the number of people they can automatically sign up to their credit card. The offer of store finance is really only a promotional tool to get new cardholders. A word of warning, just because you receive interest free terms with the finance company for your current purchase, doesn’t mean you can expect the credit card you have received from the same company to be interest free.

Similarly the credit card may offer a facility to redraw on the loan, whether that's through a card or a system that allows you to access the loan for any additional purchases within the store. This can prove a costly temptation, with interest calculated immediately on new purchases. Generally speaking the credit card provided by these companies has a higher than average rate. If you don’t believe you need the card, cancel it.

Once you have been approved for finance, you are free to take the goods home. Each month you will receive a statement asking for payment. Please note the amount required may not be the amount required to clear the loan in the given timeframe, it could simply be the amount you need to pay to avoid a late payment fee, generally calculated at 3 per cent. If you continue to pay the amount stated you could find at the end you still have a balance owing, which you will definitely have to pay to avoid penalties. Simon says it is vital to do your maths, and stresses quite often the minimum monthly repayment required won’t pay off the balance in the required time. You need to work out how much you need to pay off the finance in the given timeframe, or if you only make minimum payment how much will you need to pay at the end of the term to avoid any penalties. Make sure you do your own calculations. When you’re in the store, prior to purchase, whip out your calculator and work out the monthly payment, taking into account establishment costs and account keeping fees. Can you really afford to do this?

At the time of signing up or shortly thereafter you will receive your first statement. This is a great time to organise a direct debit payment from your account, this way you won’t miss a payment.
Check if there is a cooling off period. Some offers have a cooling off period of seven days, where you can go home think about your decision and change your mind without penalty. If there is no cooling off period, you can be certain, once you have signed your name on the dotted line you are legally bound; there is no getting out of the contract unless you are prepared to pay an exorbitant exit fee.

Ultimately, interest-free loans do offer an extraordinarily good deal if you have the means and the discipline to pay off your purchase within the free period. Before you take on any finance be quite certain you can afford it, and manage it, especially if things don’t go to plan; unexpected bills occur that eat into your budget. Never take on interest free finance if you don’t have a buffer in your budget to cover the payments. Finally, remember it’s only a bargain if you truly need it, not just because you want it.

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