How To Pay No Interest Loans
When borrowers take out a loan, they are expected to pay back the balance in full plus interest. Interest is the cost of the loan, and how lenders make money. Sometimes, consumers will come across promotions advertising interest-free loans, usually in regards to home appliances, vehicles, or electronics.
These no-interest loans are not exactly what they seem and can leave borrowers in a poor situation financially if they do not understand exactly what they are getting into.
What Is A No Interest Loan?
A typical loan requires the borrower to pay back the principal plus interest. When the lender does not charge interest, it is referred to as an interest-free loan. It is important to keep in mind that interest free does not mean zero cost, as borrowers may still be charged monthly fees and a one-time origination charge.
Furthermore, most interest free loans actually have deferred interest, which is different than no interest and will be covered in greater depth in the next section.
- No interest does not mean interest free
- Loans may still be subject or an origination charge as well as monthly fees
- May require a high credit score to qualify
- Most no-interest loans are deferred interest loans.
How Does It Work?
As stated above, most interest free loans are actually deferred interest, which can be thought of as a delay in interest charges. This typically works in one of two ways - the loan has an interest free introductory period after which interest is charged, or the loan is interest free as long as payments are current.
-Interest-Free Introductory Period: Let's say an appliance retailer offers a loan of $2500 on a new washing machine with an interest-free period of 10 months. If the borrower manages to pay off the balance within this period, no interest is charged. If they fail to pay off the balance in its entirety within the 10 months, they can be charged interest retroactively. Even if the borrower has managed to pay off $2000 of the loan, leaving them with a balance of $500 after the 10-month mark, they will still be charged interest on the entire $2500.
-Interest-Free Until Payment Is Missed: Other lenders may offer no interest for the entirety of the loan until a payment is missed. If the borrower misses a payment, they will be retroactively charged interest on the full amount of the loan, not just the remaining balance. Continuing the washing machine example, if a borrower has paid off half of their $2500 loan and is late or misses a payment, they will be charged a higher interest rate on the entire $2500.
Below is a list of the most common types of no interest loans.
- Medical Loans: Many doctors and hospitals offer interest-free loans to patients who do not have adequate coverage.
- Appliance and Electronics Retailers: The most common place no interest loans are offered are in retail stores offering appliances and electronics. These retailers are counting on customers not paying off the entire balance within the allotted period.
- Car Loans: Car dealers routinely offer interest-free loans on new and used vehicles. In order to take advantage of the interest free period, monthly payments may be higher than normal and failure to pay off the loan during the allotted time may result in paying substantially more for the vehicle than market value.
Is It Right For You?
Interest-free loans can be smart decisions for those who are certain that they can pay off the entire balance before the interest free period runs out. Anyone who has some doubt should stay away from the interest-free loans given it could end up costing more in the long run. For those considering a no-interest loan, there are several questions worth asking beforehand.
- Determine What Kind Of Deferred Interest The Loan Carries: Deferred interest can kick in if the balance is not paid off within a certain amount of time or if a payment is late or missed. Determining what kind of deferred interest the loan carries is an important piece of information.
- Ask About Fees: Some no interest loans carry high monthly fees or origination costs. If these fees are too costly, it could negate any savings offered by an interest-free period.
- Is Payment Realistic: If the borrower has any doubt about the ability to pay off the loan within the dictated period, they should steer clear as it may end up costing more over the long run.
Most interest free loans are not cost-free - they still come with monthly fees and origination costs as well as deferred interest. Determining how the deferred interest works and if one can reasonably pay off the debt in time is something to be heavily considered before applying.