O% Financing Comes With a Number of Concerns

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By Mike Gertsema, Senior Wealth Advisor

We’ve noticed a trend with new clients regarding 0% or very low interest rate financing for big purchases such as furniture, appliances, home improvement projects, cars, campers and boats. In some case, 0% financing can make sense for needed items, but using 0% financing as the sole justification for the purchase can cause many headaches for clients in the long run.

Here are some examples of purchases spurred by 0% financing:

  • Client needed to purchase a new mattress and box spring, but ended up buying a new bedroom suite because it was 0% financing.
  • Client was going to replace their vehicle with a used low-mileage vehicle, but instead ended up purchasing a new vehicle loaded with a deluxe package because it was 0% financing.
  • Client had to replace their stove, but ended up buying a new refrigerator and dishwasher to match because it was 0% financing.

Potential Pitfalls of 0% Financing

One of the pitfalls with 0% financing is the monthly required payment that lasts until the item is paid off, taking away from the cashflow budget and possibly other financial goals. From my experience, clients typically feel like they can afford the monthly payment if everything goes well.

With some loans, if you’re late with a monthly payment, there is a penalty and the terms of the loan change. A new, higher interest rate applies to the loan and it’s no longer 0% financing, making the monthly required payment higher. Sometimes the new finance charge can be double digits.

0% Financing Can Cause Problems

We’ve seen instances where a client makes a 0% financing purchase and has good cashflow until a major expense arises with their vehicle. This causes them to use their credit card, which leads to another monthly payment and a much higher finance charge, which in turn can have an adverse effect on enjoying life, vacations and their health.

Debt and cashflow are big concerns when it comes to financial planning, especially with retirement planning. If a client has an abnormally high income need going into retirement, we generally know there’s debt that needs to be paid off before a comfortable retirement is achievable. I’m not just talking about the mortgage – I’m talking about other debt.

I struggle with borrowing money for items that I know will depreciate – which is most of the 0% financing items. That’s how they entice us to purchase them in the first place. Purchases with 0% financing can hurt a budget so badly that people must reduce the amount they’re saving for retirement, which in turn can cause them to take more risks with their investments or force them to work longer because they didn’t save enough.

0% Financing and Debt Load

When working with clients, we determine their net take-home pay to see what they’re living on week-to-week or month-to-month. We’re not too concerned about how the money is spent, but we need to know their debt load so it can be addressed. We can take the emotion out of cashflow and debt concerns and get people focused on their goals, which can alleviate stress and anxiety, especially for people wanting to retire.

Check out our Cash Reserve Strategy illustration.

The illustration has three levels of money:

  • The checking account, which is most liquid. All your cashflow is managed with this account, from paying monthly expenses to saving for emergencies and short-term needs for expenses for less than a year.
  • Money Market/Savings Account, which is liquid, but with an increased rate of return. Its purpose is to replenish your checking account if it’s low and to provide money for large purchases for the next 12 to 24 months.
  • Least Liquid – Long-term investments. This is money set aside for long-term goals like college funds, retirement or vacation homes.

The Importance of Avoiding Debt – Even 0%

When meeting with clients, we generally discuss the cash reserve/savings account to be sure it’s at a comfortable level before we get into other items. We recommend having a healthy cash reserve account so clients can avoid credit cards and most debt. When people think about financial planning, they typically first think of investing, which is one piece of it. A complete financial plan consists of cashflow/debt management, investments, tax strategies, estate planning, risk management and avoiding overreaction to market events.

Please be careful and don’t get caught up in the pressures to buy based on emotion. If you have a plan in place, the odds are on your side for less stress and anxiety and more confidence.

If you’d like to learn more about financial planning and want to schedule a no-cost, no-obligation consultation, contact us today.

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