I recently ran into a situation where I was reminded that zero percent financing isn’t always really zero percent financing. In fact, most of the time when something is offered at 0% interest, the interest is just built into the loan in the first place.  

I remember a story my dad told me growing up about questioning interest and fees. 

If you want to learn about not over-paying for an item or getting trapped by the appearance of zero percent interest, keep reading! You’ll learn the most important question to ask. 

A Story of My Dad

Growing up my dad drove trucks. He had two that I can remember in my childhood – the first a red pickup with a topper and the second a white pickup that had a third door to get to the backseat. I remember thinking the third door and cd player were so cutting edge! 

I also remember when he drove the white truck home from the dealership.  My brother and I loaded up with my dad in the white truck and left my mom to drive the old red truck home. We had been home a long time and she hadn’t shown up. Turns out the red truck broke down on the side of the highway.  If you have the opportunity to talk with my mom about it, don’t bring it up! 

So, buying trucks in our house was a very rare occasion. I remember, though, my dad often told me of a time when he bought a car before the red truck. He tells of an instance when he was considering how to finance a car. He went and picked out a car from the dealership. At that point he didn’t have any option but to get financing to buy the car. So he first considered financing through the dealership. 

They gave him the terms of the loan, the length, the interest rate (which wasn’t 0%). They also told him the monthly payment.  

He then went to his local banker and asked how much his payment would be to them for the same car over the same amount of time. His story is that the bank’s deal was about $50 less a month than what the dealership offered. So clearly he chose to finance the car through the bank. 

Man handing over car keys

Car Shopping Is the Classic Example of Zero Percent Interest

The story my dad told is the perfect example and is still ever-present in today’s world. 

Oftentimes, dealers offer new cars at either 0% interest or $2,500 cash back, or some version of that. The interest rate could be a little higher and/or the cash back amount be different. But essentially they give you a certain deal if you finance through the dealership or they give you a lower amount on the car if you write a check for it.

So, let’s walk through an example. Let’s go with terms of  0% or $2,500 cash back as the terms in this example. 

If a car purchase is negotiated for a new vehicle at $20,000, a buyer then has two options: 

  1. Purchase the car with financing from the dealership with a 0% interest rate. So, the buyer would simply divide $20,000 (plus any tax, fees, etc.) over the lifetime of the loan; or
  1. Pay $17,500 (plus any tax fees, etc.) today and walk away with the car. 

The difference between $20,000 and $17,500 is 14.28%. So, to finance the car through the dealership, the buyer is effectively paying a 14.28% interest rate. The hidden cost in financing is a lot more than 0%! 

If the buyer has the cash, obviously that is the best option; however, if the individual does not have the cash any other source charging less than 14.28% is a better option than financing the car at 0% through the dealership. 

I just did a little research and one of the local credit unions in our area today is advertising that it’s auto loan rates are as low as 2.99%(this of course assumes great credit, etc.). But 2.99% loan through a bank vs 14.28% in hidden costs is a huge difference. 

A Story About Windows

About two months ago we were eating at our dining room table. I looked up and there was a water spot on the ceiling. My heart sank. We had literally just dealt with two other water leaks on the second story of our house, and my thought was here we go again. 

There were two opportunities for water to get to that spot – one of them was through windows above that space. We had a construction company come and they looked at our windows and showed us how the caulking around those windows was completely worn out. But not only was it worn out around those windows it was worn out around the other windows that were original to our house. 

To shorten the story, we began window shopping. We quickly determined that doing maintenance didn’t make any sense and replacement was our best option. 

Our house is 26 years old, and we have builder grade single pane windows… if you know anything about windows you know single paned isn’t energy efficient. If you do an internet search, the builder grade, single paned windows that were put in homes in the ‘90s are only meant to last about 15 years. So, they were well, well past their useful life. 

Ok, back to the point about 0%. So, we picked out the company and windows we wanted, which meant we got to the point of how we wanted to pay for them. The company we chose had lots of financing options, and because I’m a curious person I asked for their options. 

If we financed the windows through them, they gave us one price at 0% interest. Another option was to pay cash for the windows. The price if we paid cash was approximately 11% lower than if we financed for 0% interest.  So, 0% interest wasn’t really 0% interest, as there was an additional 11% in hidden costs in the loan. 

So, if we didn’t have cash on hand to pay for the windows, shopping around for loan terms at lower than 11% interest would have been in our favor. We knew at some point we would need windows and we have a fund for home repairs and remodeling, 

calculator with an expense sheet

Moral of the Zero Percent Interest Stories

The moral of the story is that companies think that by saying there is zero percent interest on a loan that consumers are more likely to not shop around. It sounds like a good deal so it has to be one. If it sounds too good to be true, though, it probably is! 

Additionally, some companies say that there is 0% interest for a certain number of months and then there is an interest rate. If you pay off the loan during the number of months you don’t see any interest. 

Companies have the ability to conduct extensive consumer research to determine how to get individuals to use their financing services and how they can make money by offering financing. 

Companies build in hidden costs, or they make the loan terms so that people forget to pay off the loan in the amount of time the zero percent interest lasts. 

Be a smart consumer and don’t fall for it! If you must finance something, shop around and find the lowest true rate. 

Don’t fall for 0% interest if it’s not 0% interest, and if you do finance something with 0% interest make sure you pay off the loan before any additional interest sets in (often times they’ll go back and make you pay accrued interest on the previous months!). 

So What Question to Ask to Learn if 0% interest is really 0% interest? 

If you are shopping for a consumer item where you are considering financing, always ask what the financing terms are (i.e. length of the loan and interest rate). 

Then always ask, “What is the cost if I pay cash today?”

You will quickly learn what the additional costs are to financing. If a company pressures you to sign on the dotted line at that moment, don’t fall for it. If they’re a reputable business, they are willing to sell you the same item tomorrow or next week for the same cost as today. 

Take time to conduct due diligence on what makes the most economical sense so that you aren’t over paying for an item due to expensive interest costs. 

About MPower Co

MPower Co is a financial education and coaching company for consumers like you. Follow us on Facebook or Instagram to learn more about personal finance and positive psychology. 

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Want to Read More? 

If you liked this blog post with our personal story about car shopping and window shopping, perhaps you’ll like this post about when we had to make a choice about gifting a car. 

If you like more technical financial detail, perhaps you would prefer to read this article about emergency funds