Don’t be Fooled by No Interest Financing

Rooms To Go, America’s largest furniture retailer has been advertising a “no interest until 2011″ offer for buying furniture at their stores. It appears to be a sweet deal, borrow the money for your furniture at no interest, and then you could use that money to pay down high-interest credit cards or achieve a return by investing that money (or you could just spend it).

Unfortunately, there is no such thing as no-interest financing!

Here’s why: When you buy something without paying cash, you are paying for two things. You obviously have to buy the item, but you also pay for the money to finance that purchase. Money is never free, because of the time-value of money. Lets use the Rooms to Go example to illustrate the point:

1. Rooms To Go sells you a set of furniture for $5000 with the “no Interest” until 2011 financing plan, lending you the money to buy the couch.

2. Rooms To Go must either come up with the cash for that loan by borrowing the money or using cash from operations. Typically, companies borrow the money so they can use their cash from operations to invest in their operations (opening new stores, hiring people, advertising, etc). Even if they didn’t borrow the money, there would be a cost to the money, since if they could get a 10% return on investing cash in opening a new store, the opportunity cost of that cash would be 10%.

3. AAA Corporate bonds are trading now at a 5.1% yield. That means, if Rooms To Go had excellent credit, they could borrow for as low as 5.1% interest. However, there are other costs associated with lending money to customers for furniture. Some of those customers – likely as many as 10% of the customers – would default on the loans. There are also costs to administer the loans, billing, collection, etc. All together, the cost of the loan would represent an interest rate (or borrowing cost) of 7-12%. Assuming a 10% interest rate, the results are scary:

A four year “zero interest” loan would cost $1020 in interest, you just pay it up front! This assumes a 10% borrowing cost.

You may say, “hey – that doesn’t matter to me, because Rooms To Go is paying the interest, not me.” Well, that is not entirely true. Rooms To Go is selling you a furniture set for $5000, but they are covering borrowing costs of $1000. How much is the furniture really worth? $4000! You are not getting an interest-free loan. They are just baking the interest costs in up front in the purchase price. To make matters worse, there may be things in the fine print that trigger huge penalties when you miss a payment or pay late, even if it is just a simple mistake.

Low or no-interest offers are not a good reason to finance a depreciating asset. It very rarely makes sense for an individual to finance a depreciating asset like furniture, a car, a TV, etc. Don’t fall into the traps of slick financial packaging. Pay with cash, and buy what you can afford. One other thing – when you buy with cash – make sure to use any financial offers as a bargaining chip. Certainly never pay $5000 for a furniture set with a “no-interest” loan offer, because you are paying up-front interest for a product when you aren’t even borrowing any money.

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