Imagine a scenario where you’ve got the money to make a large discretionary purchase and you’re given the option to finance it through the retailer at interest or open a credit card with an introductory zero interest rate. What would you do — pay cash or just finance it?
I get a lot of credit card offers that go straight to the shredder, but every now and then something comes along that looks interesting. I only have a few cards, so opening a new line of credit is a decision that I take very seriously. The card companies are offering enticing incentives to sign up: cash back, airline miles, point redemption systems, discounts on different shopping categories, and — most importantly — zero interest for a fixed term (usually 12 months).
When it makes sense, and how it can fall apart
If you qualify for a card with a zero-interest rate and can manage the payments responsibly, it absolutely makes sense to use this as a financing option.
The catch, of course, is that you need to be able to pay off the balance before the teaser period expires, otherwise you will pay interest on the original balance in arrears. This is even more challenging if you continue to make other purchases on the card and fail to effectively pay down the balance. It can become a debt spiral if you don’t have the willpower to manage it responsibly.
Illustrating the offer
Let’s say, hypothetically, that you’ve been saving up to make a big ticket purchase — maybe some furniture or audiovisual equipment for your new home — and it will cost a total of $5,000. In some cases, retailers may offer low-interest financing; but in general, that’s not really a good deal and you just shouldn’t go there.
But here’s how a zero-percent credit card offer with 2 percent cash back compares to financing at something really low, like 3 percent, just to see how the offer works and where the breakeven point might be:
|Financing||0% Credit Card|
|Cash Back %||0.00%||2.00%|
|Initial Investment $||$5,000||$5,000|
|Cash Back $||$0.00||$100.00|
|Effective starting balance||$5,000||$4,900|
|Proposed monthly payment||$423.47||$408.33|
|Balance in month 1||$4,589||$4,491|
|Balance in month 2||$4,177||$4,083|
|Balance in month 3||$3,764||$3,675|
|Balance in month 4||$3,350||$3,266|
|Balance in month 5||$2,935||$2,858|
|Balance in month 6||$2,519||$2,450|
|Balance in month 7||$2,102||$2,041|
|Balance in month 8||$1,683||$1,633|
|Balance in month 9||$1,264||$1,225|
|Balance in month 10||$844||$816|
|Balance in month 11||$422||$408|
|Balance in month 12||$0||$0|
Find the advantages
Three percent versus zero percent is a no-brainer, but the monthly payment isn’t all that different here — and you only avoid about $81 of total interest. Either way you’d be taking out a line of credit, so my vote would be for an institutional credit card that you can use anywhere (bonus points if it’s affiliated with your existing bank or creditor).
See what the experts at CardRatings.com say about the Citi Simplicity ® Card in their review.
The cash back is a nice bonus, giving you an immediate discount on the purchase too; but since it cannot be used in lieu of a monthly payment, I’ve assumed that it is taken off the starting balance.
Be sure to read the fine print on the offer, though. If there are annual fees associated with the card, it could negate some or all of the advantages of the offer.
Another good point about the credit card is that the minimum payment will be much lower, whereas retail financing would have a fixed monthly payment. This means you can pay it down faster in some months and scale it back in others, depending on your cash flow.
Liquidity and such
The other nice thing about a zero-interest card is the ability to use it to buffer your budget since it’s not imperative that you pay the entire balance each month. For example, I financed a purchase on a card that is giving 5 percent back on gas and groceries, things I routinely purchase. So while I’m paying down the balance, I’m also occasionally using the card to make those purchases. This adds a nice buffer to my monthly budget and delays the cash flow until the next month. The cash back I earn on the card goes directly to the balance, which helps offset the amount I have to pay.
One thing I haven’t explored is to open a certificate of deposit — say a six-month term — with the funds I didn’t use to make the purchase, which would sweeten the deal a little more.
Is purchasing on credit worth it if you’re able to pay it off in time? What is your experience with zero-percent credit cards? How do you maximize the advantages of this kind of offer?