Thursday, June 14, 2012

When is "Zero Interest" Not Zero Interest?


Dear Investor Juan,

I'm planning on getting a credit card just for the purpose of getting a highly needed device (and I mean highly) using a 24-month zero interest installment plan. I don't really know much about this but is there always a catch to this thing? I'm sure I can pay the necessary monthly amount but I just wanna make sure that I will only pay for the device with a true zero interest and no other random fees added. Thanks.


Dear Marvin,

"Zero interest" payment plans work this way. Say you want to buy something with a sticker price of 120,000 pesos. Then the a store sales representative approaches you and tells you that the item is available at zero interest for 24 monthly installments. This means exactly what it seems it means: you use your credit card to pay for the item, and you will be charged 120,000/24 = 5,000 pesos per month, without any additional charges. In this sense, the offer is "zero interest".

However, the monthly installment for this item becomes part of the minimum amount due as long as it is not completely paid. Which means that if your usual minimum amount due is 500 pesos, on the next billing statement after you purchase the item the minimum amount due will be 5,500 pesos. If you fail to pay this amount by the due date, then you will incur a significant financial charge and your purchase will not be zero interest anymore.

Also, and this is something that a lot of us are not even aware of, such schemes are zero interest only insofar as the "real price" of the item is the same as the sticker price. I know this may be confusing; it says 120,000 on the tag, how can that not be the real price? Well, ask the sales rep how much you would have to pay if you paid "cash" up front--meaning the full amount in one cash payment. The sales rep will consult someone or a record book, pause, and 9 out of 10 times quote you a price that is 5 to 10% lower than the sticker price. Don't believe me? Try it. I do it all the time when I shop for gadgets and other similar stuff, both in the Philippines and here in Hong Kong.

If the cash price is lower--say by 10%--than the sticker price, then paying 5,000 for 24 months for it would not really be zero interest since you would essentially be borrowing money at approximately 10% per year (I'll leave it up to you to compute the exact implied monthly/annual interest using this example). Does this mean you shouldn't avail of the installment plan anymore? Of course not. Maybe you don't have enough cash at the moment to pay up front and you badly need the item, and/or maybe borrowing at 10% per year is acceptable to you. What's important is that you know that you have options. You'll lose nothing by asking, right?

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