Play it safe with 0 percent on purchases
5 February 2016
A card with an introductory 0 percent APR on purchases can seem like an answer to your cash-strapped prayers. envelope advertising 0%
Yet before you apply, you’ll need to figure out if you’re the type of person who can use one of these deals safely, or if you’ll incur massive financial damage.
“Certain people can use this and essentially get an interest-free loan, whereas other people might not be able to make the payments they thought they would and then end up paying even more,” says David Weliver, founder of personal finance blog Money Under 30.”
How no-interest promos work
For a certain number of months after opening the card (generally 6 to 15 months, depending on the card), no interest will accrue on new purchases. After that period expires, the go-to interest rate will be charged on any outstanding balance.
Zero percent on purchases can be a good deal for the consumer – and for the bank, too.
“Even though it’s just for a promotional period, the bank is thinking you’re going to have this card for a while,” says Katie Bossler, a financial counselor at non-profit credit counselling agency GreenPath Financial Wellness. “They hope you’re going to like it and you’re going to continue to use it.”
Zero percent offers on purchases from major banks are not to be mistaken for deferred-interest deals (often the domain of store cards). Differed-interest deals start off similarly (no interest charged for a certain number of months). But interest is being calculated that entire time — and when the promo period runs out, you’ll be charged retroactive interest, dating back to the original purchase date.
“If you’re at the computer store or furniture store and they’re saying you can pay for it with their card, that’s probably a deferred-interest situation,” Bossler says. “If you have a card with a major bank, that’s probably going to be a promotional 0 percent rate.”
We’ll look at some situations in which savvy consumers might use 0 percent offers on purchases in a moment, but let’s set some ground rules first:
Calculate your monthly payment: Pretend that you’re taking out a loan and MUST clear the balance by the end of the term.
“Take the cost of whatever you’re buying and divide that by how many months the promotional period lasts,” Bossler says. “Make sure you can afford to pay it off within that time frame.”
Because this is a credit card and NOT a loan, you’ll technically be allowed to pay just the minimum each month if you want. But don’t do this — paying the minimum won’t clear your balance by the time the 0 percent period expires.
“What you don’t to have happen is you make the minimum payments and then [the interest rate] turns into 18 percent and you’re stuck paying that for a couple years,” Weliver says.
Make sure that monthly payment fits in your budget: Remember that monthly payment you calculated above? Take a good hard look at that number. Then, take a good hard look at your budget and your bills.
“If you’re counting on a tax refund or a bonus, make sure that’s actually going to happen,” Bossler says. “Have some kind of plan for how this is going to play out.”
When to use 0 percent deals — and when not to
Now that you know the safety rules, here are some times to consider a 0 percent offer on purchases – and when you should probably back away.
When to consider it
In general, Weliver says, these deals are best used when you’re making a large purchase (or series of large purchases in quick succession) and want more than a billing cycle to pay them off.
Examples might include wedding expenses, vacation expenses and home improvement projects.
Ideally, such purchases will be planned. However, Weliver says, his wife got a card with a 0 percent period to pay for a surgery while she was in school.
“Sometimes you’re in a tight corner,” Weliver says.
So, perhaps a more realistic take-home message is to make sure your purchases are clearly defined and contained. If you’re using the deal for wedding purchases, don’t use the card to buy a friend’s birthday gift. If you’re using it for home improvements, don’t use the card to buy dinner.
“I think [0 percent deals are] best used for that one-time large purchase or those couple of large purchases right after you get the card,” Weliver says. “And then you don’t use the card again until it’s paid off. That way you don’t get into the habit of putting everything on the card and then the 0 percent runs out.”
When to avoid it
If you’re looking to bridge the gap during a time of low cash flow (perhaps you’re between jobs), you’re pushing your luck.
“That really makes me nervous,” Bossler says.
If you don’t get the job you were counting on, you could find yourself in high-interest debt without the ability to get another 0 interest offer. So, if you have any other options,
Bossler says, take them. Try to make things work on unemployment (if you’re receiving it) or move in with family.
“Live within your reality,” she says. “A [0 percent interest] card is maybe going to allow you to maintain a lifestyle that you can’t afford.”
In addition to being wary of debt, consider the effects a 0 percent deal can have on your credit:
High utilization: Using up a lot of your available credit (you generally want to keep it under one-third of your limit) can hurt your credit score. That means the very nature of these 0 percent deals could spell trouble, if you don’t have enough available credit on other cards to balance things out.
“Let’s say you get this card and it has a $5,000 limit and you buy something that’s $4,000,” Weliver says. “Your utilization on that card is going to be high, and that can have a big impact on your score until you pay that down.”
Missed payments: Don’t just make that purchase and forget about your card for the next 12 interest-free months. You still have to make your minimum payments – or you’ll face credit damage for missed payments.
“Zero percent interest on purchases doesn’t mean zero payment,” Bossler says. “You still have to make the minimum payments. It’s not a zero-payment loan.”