You’ve probably seen them before: the “same as cash” or “zero percent” financing loans that seem just a little too good to be true. Typically, they’re offered for products that many people don’t have the cash to pay for upfront: refrigerators or sofa sets, for example.
“Many stores that offer big purchases, like appliances, home improvement materials, or expensive electronics will offer programs like this,” says John Ganotis of CreditCardInsider.com.
Some car dealerships or credit cards offer similar terms. The idea is the same: you take out a loan or line of credit and, for a specified promotional time period–usually six months or a year in the case of credit cards–your balance won’t accrue interest. You may not even need to make payments during that time.
But it turns out that not all of these offers are created equal. Some might be tempting for the financially savvy consumers who want to save on interest and, say, invest their money during the promotional period. But others are targeting a different demographic of consumers and affecting their credit in a much different way. Before moving forward with any zero-percent loan, you’ll need to consider a handful of details, making sure you understand the fine print and how the account can affect your credit.
Who Can Qualify for 0% Interest
If you read the terms of zero-percent interest car loans, many of them are limited to “well-qualified” borrowers, which means you need a solid credit score in order to qualify. According to Edmunds, as a general rule, you should be able to score a zero percent loan if your score is at least above 700. This principle also applies to most balance transfer credit cards.
Other products, such as store credit cards and in-store financing for furniture and appliances are a little different. They typically have lower requirements, Ganotis explains. “Store cards and financing offers are often available to people with fair or bad credit, so it’s especially important to understand the terms to avoid further credit damage,” he says.
Indeed, many of these cards include specific details in the fine print that can be financially dangerous: crazy high interest rates that kick in after the introductory period, for example.
If there’s one key takeaway here, it’s that all zero-percent offers are not created equal. The differences in credit requirements are a sign that there are differences in the ways these accounts are handled and how they can affect your long-term financial health.
Where is the line drawn?
Here are some basic guidelines for which zero-percent products can be a good idea and those that should likely be avoided. This is a summary, and of course there may be exceptions.
Auto loans: These require excellent credit and typically don’t have many hidden “gotchas.”
Balance transfer credit cards: These require good to excellent credit, and can be a smart debt repayment tool. However, there are several caveats and interest rates will likely explode after the promo period. You can read more in our post about balance transfers.
In-store credit cards: These might come in handy on occasion, but have hidden caveats. Many of them are actually “deferred interest” cards that still accrue interest during the promo period. If you don’t pay off the card by that time, you could be on the hook for all of that interest.
Furniture loans or other types or in-store financing: These should be avoided if at all possible. Their terms aren’t consumer friendly and their presence on your credit report can potentially lower your score and/or be a red flag to future lenders.
What to Look for in the Fine Print
In many cases, zero-percent financing comes in the form of a revolving account instead of a loan. “Consumers should know that they are opening an open-ended revolving credit card account and not a close-ended installment contract,” says Kevin Haney, a former credit bureau executive who currently runs the Credit Bureau Insider website. “They should know that they have [a limited amount of time] to repay the balance interest free, and must make every payment on time or risk losing the deal.”
As Haney points out, there are a few common drawbacks to these types of offers that you’ll find in the fine print. For one, after the promotional period ends, they charge a much higher interest rate. A rate as high as 30 percent isn’t uncommon. Any new charges to the account might also accrue interest at this higher rate while the balance remains unpaid, Haney says.
You also want to watch out for “deferred interest clauses.”
“With some offers, if you make a late payment or don’t pay off the whole balance by the end of the 0% period you may owe interest all the way back to the beginning, due immediately,” says Ganotis. In other words, one mistake could cost you quite a bit of money.
How These Loans Affect Your Credit
Let’s say you read the fine print and know what you’re getting into, though. You’re prepared to pay your balance responsibly before the promotional period so that you really can benefit from a 0% interest loan.
There’s one more drawback, though: the loan can affect your credit negatively.
These types of accounts are often reported as “consumer finance loans,” which FICO reviews less favorably than traditional lines of credit, like credit cards. Since consumer finance loans usually have more lenient qualifications, some lenders may look at them as a red flag for poor credit.
However, as Haney points out, their affect on your credit utilization ratio has a more significant impact on your overall credit if they are reported as revolving. “The loans affect credit the same way that a new credit card with a high revolving balance would – because this is what they are,” Haney says. “The consumer opens a new credit card account, and begins with a large revolving balance relative to the account limit.”
Your credit utilization ratio is the amount of credit you have available to you versus how much of it you actually use. Ideally, you want a lot of credit available while only use a small portion of it. This ratio makes up 30% of your FICO score. When you take out a 0% financing loan, you’re opening up a new line of credit that’s maximized, meaning you’re using a larger portion of your overall credit.
Like anything that seems too good to be true, these loans can be appealing, but they have a number of serious drawbacks you should think about. If you’re considering one, always make sure to read the fine print, but also understand that, beyond the “gotchas,” these types of loans can impact your credit, too.