Among the different types of finance deals that are offered by various providers across the marketplace, interest free loans are among the most attractive. Borrow $25,000 and not pay a cent in interest? Who wouldn’t be interested in a deal like that?
You know what they say about if things look too good to be true? Despite this, interest free loans generate a huge amount of interest, with many people applying and ultimately taking out these products.
What is an Interest Free Loan?
On the face of it, an interest free loan does exactly what it says on the tin. There won’t be an interest rate for the loan, and you won’t pay any interest. However, do you really think a lender is going to give you a loan and not make anything out of it themselves?
So Where do the Charges Come From?
There are two main types of interest free loans currently in the marketplace:
- Personal loans that are interest free until your final repayment
- Personal loans that are interest free for a fixed period, such as 12 months, before interest becomes payable
Interest Free Until Your Final Repayment
Loans that are totally interest free may seem appealing, but instead of paying interest you’ll pay a monthly “Service Charge” or “Merchant Fee” along with your loan repayment. This will usually be a percentage of the total balance or a fixed amount, calculated in the same way a minimum payment for a credit card would be.
So, while you don’t pay any interest, the fees you pay will usually make the loan far more expensive than if you took out a traditional personal loan, where fees and charges are all built into the comparison rate so you know exactly what you’re paying.
The table below highlights the difference in what you might pay when you take out an interest free loan vs. a regular personal loan.
As you can see from the figures, by taking out an interest free loan you’d be putting yourself at a huge financial disadvantage and potentially cost yourself over $10,000 over a five-year loan period.
Interest Free for a Fixed Period
Loans that are interest free for a fixed period do appear to be offering you a better deal, but there’s a few things you need to be mindful of when considering these loans:
- The lender is banking on you not repaying the loan within the interest free period (in much the same way a credit card provider offers you an interest free period).
- The interest rate that kicks in following the interest free period is likely to be higher than the interest would be on an equivalent personal loan from elsewhere. This means that your regular repayment could be much higher – a loan that is affordable during an interest free period could quickly become unaffordable if your repayments aren’t balanced to give you a fixed repayment amount over the full length of the loan term.
- Remember that the higher interest rate applied will likely mean you end up paying at least the same, and usually more, than if you had taken out a traditional personal loan.
- A lender may offer an interest free period, but also penalise you heavily for repaying your loan early, so you’re locked into either paying at the higher interest rate or paying a hefty early termination charge.
As we can see, you would need to make a weekly repayment of almost four times the amount on an interest free loan in order to keep this particular loan interest free.
Finally, let’s now look at what you’ll repay if you only pay the minimum payment on your interest free loan. For ease of comparison we have assumed you will clear $6,000 of the balance during the interest free period at $115.38 per week.
Although you won’t spend as much than with a loan that is purely interest free where you pay the charges only, you’re still losing out on $300, not to mention any fees that may come on top of the comparison rate. In our example above we have also used what would be a very competitive interest rate – at NOW FINANCE our highest interest rate is [hi_comp_rate_un] – and it may not always be possible to find interest free loan deals at that particular rate.
Can Anyone Benefit from Interest Free Personal Loans?
If you have the income to pay off an interest free personal loan in a short time frame then they may offer you an opportunity to borrow at a relatively cheap price. Yet at the same time, if you have nearly $2,000 a month after all your other expenses to service a loan, you are probably in a position where you wouldn’t need to save for too long to make a big purchase, so you may question whether it’s worth the hassle. Also, if you have such a level of disposable income and also have a clean credit history, you can probably borrow a significant sum of money at an excellent interest rate anyway.
In general, interest free loans are only going to be useful if you want to make a small purchase and can stick to a set repayment amount to ensure you repay the loan before interest kicks in. This is the same principle as using interest free credit card deals; they’re fantastic so long as you can commit to ensuring the balance is zero before the end of the interest free period.
Look at the True Cost of Interest Free Loans
Interest free loan deals may seem attractive, but the interest free message will usually be masking the true and full cost of the loan. Instead of being taken in and making a decision based purely on the interest rate, look at the regular repayment figure and the full cost of your loan, as well as the charges and fees schedule, and see what the full cost of the loan actually is.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs. If this article relates to the acquisition, or possible acquisition, of a particular credit product you should obtain and consider the relevant disclosure documents before applying for the product.