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November 26, 2020

Nothing is Free: The Interest Free trap and how not to be held captive

Nothing is Free: The Interest Free trap and how not to be held captive

Buy now and pay later, interest free – sounds like an amazing deal, right? When something sounds too good to be true, it usually is – but this type of micro-credit has been around for quite some time, and fortunately or not, it is here to stay! So many people in Australia have made a credit purchase through an interest free buy now pay later service – but if there is no interest to be paid back to creditors to compensate them for the risk of loaning out their money, then how do interest-free loans work?


Interest free and buy now pay later (BNPL) financing encourages consumers to buy without a second thought and then leave the store. With the growing popularity of services such as AfterPay, Zip Pay, Latitude Pay, Klarna, Sezzle and Humm, consumers can have the satisfaction of buying whatever they want, even if at the time they don’t have the full amount of funds (similarly to interest-free personal loans).

Whilst these short-term financing solutions offer flexibility and convenience for customers, the use of these interest-free financial services can in fact come at a cost. Once the interest-free period is over, or if you miss a payment, you will be charged a (sometimes exorbitant) penalty fee and interest.

Currently, in Australia, there is no requirement for these micro-lenders to do a credit check prior to granting finance to its applicants, however, as the popularity of no interest financing rises among younger generations and cannibalises credit card sales, calls for tougher industry regulation also continue to grow (and especially against those services that sell themselves as an interest-free financial company)(1).


What are the Pros and Cons of Interest-Free Financing?

what are the Pros and Cons of Interest-Free Financing?


Pro: If you have the income to make payments even if you don’t have the money straight away, then interest free loans or a buy now pay later service can work for you, especially if you need to finance an emergency purchase but you don’t get paid until next month.

Say, for example, your fridge blows up and you don’t have the money to buy one right now when you really need it. You could take up an interest free offer, purchase a new fridge for $1500, pay off $200 per month for 12 months and be fully paid off in a year without paying a cent of interest.

 

Con: Consider the same scenario of your fridge breaking down. If you go for an interest free offer but only pay the minimum repayment each month, once the interest free period elapses, you will likely be charged around 30% interest on the amount remaining. That is a LOT of interest debt that can quickly add up and will very likely cause you to become stressed about having more debt if you can’t pay it off ASAP. Interest-free personal loans, therefore, aren’t always interest free!


Once you weigh up the pros and cons, there are a few things you should consider before taking up an interest free offer or use buy now pay later financing: 

  1. Know what your repayments will be. Make sure you work out what you will need to pay each month in order to avoid paying interest. If not, you will find the minimum payments won’t ensure you have paid off the loan in the interest-free period. 
  2. Ditch the credit card after the purchase. Most interest free deals will come with a credit card. This card will most likely have a higher-than-average interest rate and any extra items you buy with this card will probably not be interest-free. Give it to somebody you can trust to look after it for you or chop it up and throw it out. 
  3. Be aware of the hidden fees and charges. As per the title of this blog- nothing is free. Most interest free loans come with a setup fee (could be over $100) as well as a monthly fee. Also, be sure to double-check the terms and only take up the offer if the contract allows you to pay more than the minimum monthly amount. Make sure you read the fine print and take these sneaky clauses, fees and charges into consideration. 
  4. Set a reminder. It is all well and good to buy something interest free and think 12 months is ages away, but the reality is that time flies! By the time you realize it was a year ago that you purchased your fancy new flat-screen TV, the additional interest charges on any outstanding balance will rack up faster than you think! Make sure you add reminders to your calendar and adjust your budget to make sure you start making payments on interest-free personal loans before it is too late. 


Are there other interest free options?

Due to the traps associated with interest free loans and buy now pay later financing, anyone who really wants to be in control of their finances would advise against signing up in the first place, but this does not mean you have to miss out on the things you want. Consider creating a sinking fund or saving up for such purchases with a goal savings account. Budgeting for discretionary purchases is key to ensuring that you can still pay off debt and have fun without going over budget or undermining your goals! 


It’s too late to stop interest, what can I do?

If you are one of the many people who is already experiencing financial stress due to overdue interest free loans, there are some things you can do to pay off debt and/or ease the pain.  If you are having trouble making repayments, act quickly by facing the problem and contacting the credit provider to explain your circumstances.

In an instance like this, you may be able to apply for a hardship variation to the contract and if the provider refuses then you can complain through an independent resolution scheme.  If you are unable to sort out your financial problems, or there are other factors which need to be considered, you can also reach out to one of our Credit Counsellors on 1300 003 328 for debt help. As always, make sure you are well informed, know your situation, be honest with yourself and don’t throw stones in your own path by buying things you simply cannot afford. 

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