It seems as though almost every business, car dealership, and bank these days are offering 0% financing on all their loans. Is that even possible? I mean, why would a bank offer you a loan at the cost of zero? Sadly, the majority of consumers fall for this trick and actually believe they are getting a great deal on a loan.
The truth is, 0% financing is not really 0% financing. In fact, it’s probably (in most cases) much more expensive than the old fashioned 3.99% car loan we are all used to hearing on TV ads, billboards and radio ads.
Here’s a detailed explanation of how the 0% financing works, and 6 reasons why I absolutely hate it and why you should too…
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How 0% Financing, Isn’t Really a 0% Loan
Imagine you are a car dealership. You specialize in selling Honda vehicles and your dealership is called “XYZ Honda.” You’re doing inventory and see that it costs you about $15,000 to purchase Honda Civics at wholesale cost from Honda, at which you turn around and sell the Honda Civic at retail prices around $17,999.
You know that most customers that visit your dealership need a financing option, so you have partnered with a local bank to provide special financing to customers who purchase from you.
Essentially, your dealership becomes the banker for the local bank and issues loans on the bank’s behalf with the bank’s money to your customers who purchase a vehicle from you.
The way this works is nearly the same as purchasing vehicles at wholesale from Honda, but this time you’re purchasing loans from the bank at a wholesale price.
The bank agrees to offer you the ability to issue loans to your customers who buy a car from you and will charge your dealership a 2.99% fee for every car loan you issue.
Rates higher than 2.99% on the loan is revenue for your dealership.
Your first customer of the day purchases a Honda Civic from you and wishes to take out a $15,000 loan with $2,999 as a down payment. He is approved for a loan at $15,000 according to the bank’s approval guidelines.
As the owner of the car dealership, would you offer this customer a 0% interest loan, knowing that you have to pay the bank 2.99% in fees on that loan? I DON’T THINK SO!
Why would anyone be able to offer a 0% financing option? Included in most loan documents is a fee statement, showing a breakdown of all the processing fees, paperwork fees, transaction fees, etc. that are in addition to any finance charge or interest rate.
On top of that, in the case of the car dealership, they have complete power in the price of the vehicles they sell.
The 2.99% cost that they would have to pay to the bank must be made up somewhere in the transaction and is most often found in selling the car at a higher price, including more fees in the fee statement, or something similar.
Yup, they can be a sneaky salesman, and the sad thing is that most people get bit when they see the 0% financing options.
Zero percent financing doesn’t just apply to cars; it applies to any type of loan.
Other popular places where 0% financing is offered are places like appliance stores, real estate loans like a home equity line of credit or loan, or even any type of personal loan.
Other uses of loans may be for borrowing $5,000 from the bank to turn around and turn that $5,000 into $6,000.
Some do this in the stock market, with real estate, or investing in a small business idea. The options are many. Here are 6 reasons I hate 0% financing options:
1. You’re most likely paying more in fees, not less
As briefly shown in the example of the car dealership above, in most cases, you are probably paying more than a regular 3.99% interest loan.
How? Rather than paying 3.99% in interest rates, many companies will take that cost and just allocate it elsewhere in the transaction.
That may include increasing the purchase price, including higher fees for processing, application fees, etc. Most likely they would spread out that 3.99% interest fee among multiple areas, not just one.
2. Only the top credit ratings get approved at 0% anyways
To add to the first bullet point, while offering these “0% financing options” in most cases, they even require the highest credit scores to even get approved.
In other words, they may be allocating that otherwise 3.99% fee elsewhere, and still only be offering that deal to the best credit scores, like those with an 800+.
If your credit score isn’t perfect, you can expect to have a basic 2% or 3% interest rate on top the “0% financing” option.
3. Impulse purchases are hard to turn back on once you’re hooked
Ever gone to the grocery store with an empty stomach, and end up spending twice the amount you planned on spending? Or how about visiting the mall to buy a new pair of shoes, yet to come home with a new pair of shoes AND an entirely new wardrobe?
Banks know that money can often get the best of us when we have access to large amounts of it. Picture yourself driving your favorite vehicle for a test drive at XYZ Dealership.
It’s the vehicle you’ve been dreaming of since you were a kid, and absolutely love everything about it.
What started out as a “window shopping” trip suddenly becomes a discussion on how to make the purchase.
You are hooked, and there’s no turning back once you agreed to the test drive…
4. You likely spend much more when buying on credit
Perhaps you are looking to remodel your kitchen. Upon discussing the changes, you want to make with your spouse, you decide on a budget of $10,000 to make some minor updates and expansions.
You figure you can take out a basic home equity line of credit to cover the costs and can pay it back in just a few short years.
After meeting with your contractor, he makes the occasional comment “well if you’re going to change the surface of your countertops, you might as well upgrade to granite for the small change in cost…” along with many other similar upgrades.
You meet with your banker and discover you are approved for a $15,000 home equity line of credit, just enough to cover the upgrades “suggested” by your trusted contractor.
What started out as a $10,000 kitchen upgrade increased by 150% to a $15,000 remodel…
5. It will slow down your path to wealth
Multiple studies on how millionaires became wealthy clearly show that a large part of their success is credited to their hate towards debt.
When financing your purchases, you not only slow down your path to wealth, you go backward in most cases.
In popular books like “The Millionaire Next Door”, studies on how these millionaires became wealthy indicate they pay for things in cash, never borrow money, and invest regularly.
In fact, millionaires may be the ones lending the money in many cases, getting that large return on investment from the borrowers!
6. Borrowing for arbitrage can be very risky
A popular reason people may borrow money, specifically for the so advertised 0% financing options, is to take advantage of arbitrage.
Arbitrage is the difference in prices of products and services between different markets.
For example, I may be able to go to Walmart’s clearance aisle and buy some old cell phone cases for pennies on the dollar, then go and sell those cell phone cases on Amazon or eBay for $5 each and keep the change in prices as profit.
This is just a basic example but applies to all products and services and markets.
This may be buying a small business and reselling it on a different market for a higher price.
This is often an enticing investment for entrepreneurial-minded individuals who think they can borrow money and make more in profit then they paid for the cost of the loan.
Although this often sounds enticing, the majority of larger arbitrage transactions that require the assistance of a bank loan are riskier than most deals and often result in a large loss.
Make Money Work For You, Not The Other Way Around
Hopefully, by now, you have captured my vision and hatred toward 0% financing options.
Using loans of any kind in most cases is delaying your ability to build wealth.
The idea is to make money work for you so that you can live a financially independent life.
The sad thing is, most companies and individuals that offer these so-called 0% financing options are becoming very wealthy from the majority of individuals who give into the enticement.
These days, especially with consumer debt hitting its all-time high, your best bet is to use your own money for major purchases and follow the proven sound financial tips suggested by today’s wealthy individuals.
Adebayo
Website
I am a pulmonary and critical care doctor by day and personal finance blogger/debt slaying ninja by night.
After paying off close to $300,000 in student loan debt in less than 6 months into my real job, I started on a mission to help others achieve the same. There is no magic to this than to strap up and get it done. Some of the ways we achieved this include side hustle, budgeting, great negotiation skills, and geographical arbitrage.
When I was growing up, common knowledge in Nigeria is that there is one thing you cannot trust anyone else with, and you guessed it – your money.
Being frugal came easily to me based on my background. However, the concept of building wealth did not solidify in my mind until when I finished medical school. I wish I knew what I know now when I was 14. Still, I don’t know enough and I am constantly learning to improve my knowledge.
My goal is to reduce financial illiteracy among young professionals. I am catering to the beginners – babies and toddlers in financial literacy.
