Get Your Free Samples of Debt Here
by Richard P. Halverson
A few years ago my twenty-year old riding lawn mower finally decided it did not have the energy to climb over even one more molehill in my backyard. (OK I admit it. After 20 years it is obvious I have never cared much if my neighbors see me driving the latest model in lawn mowers or cars.) So the mower went to that great reward awaiting all faithful mowers – the recycling center – and I went to Home Depot. I was shocked to learn that a new riding mower would cost more than my first car and it didn’t even have a driver side air bag. Unfortunately, keeping a flock of sheep to trim my grass would be illegal in my neighborhood so I decided I would have to buy the mower.
When I said, “O.K.” to the salesman he immediately asked if I would like, “A free sample of debt?” with my purchase. Well, he didn’t say it exactly that way but that is what he meant. First he wanted to know if I wanted to put it on my Home Depot credit card. I told him I didn’t have a Home Depot credit card. His eyes lit up. (Probably because he made next to nothing selling me the mower but he probably won employee of the month for selling me a credit card.) He explained that if I would apply for one I could finance the mower for one year interest free and I would get an immediate discount on the purchase of the mower. No payments for one year? No interest if I pay on time? An immediate reduction in the cost of the mower? What a deal! I did it!! Then I spent one year feeling nervous about it and having to contend with my wife asking me four to five times a month if I was sure I hadn’t forgotten to pay. I was even ticked when, for the fun of it, I got one of those on-line credit reports and there was that liability under my name. (You can see how we feel about debt financing around our house.)
IT IS HARD TO ADVISE PEOPLE TO PASS UP FREE DEBT – BUT I DO!
These offers of free debt samples are everywhere. Cars, furniture, computers, credit card transfers, you name it. As a financial person it is hard to argue that it is irrational to postpone paying for something if it does not raise the price. I must say this was a good deal for me. It should be hard for me to advise anyone to pass up a free sample of debt. But I usually do. Here’s why.
People usually do not pay it off – despite their good intentions. I have seen estimates that perhaps 78% do not pay on time. In the case of the lawn mower the interest rate was 21%. The mower cost $2,000 (sorry for the personal details.) If I had gone one day over my free year the cost of that mower would have been $2,420.
Of the 78% who do not pay on time I do not know how many actually intended to pay off the entire amount at year end and how many simply felt that delaying the start of their monthly payments a year was smart. Both are bad.
I’ll have the money next year. Sometimes we believe we can pay the $2,000 in cash the next year even if we do not have it today. We may figure next year will be easier financially. Or we might have a plan. We might reason, “I will make monthly payments of $167 to myself in my savings account for a year. Next year I will have more than the $2,000 I need and I can keep the interest I have earned.” Financially, that is brilliant. But often without the pressure of a real payment to make it is easy to let those self-payments slip. Many people find themselves one year later with no more free cash than ever and a lawnmower that has gone up 21% in price.
I have to make payments anyway, waiting a year to start is good. Some people just figure they are going to make payments regardless and they think it makes sense to delay them a year. It doesn’t. First, if a person absolutely needs the item and it must be financed most people today can find cheaper financing than 21%. Second, all that interest becomes part of the total amount that must eventually be paid back. Even if a person must finance the item at 21% she is far better off to begin payments immediately than to wait and let interest accrue for one year. In this example assume payments will extend for two years after payments begin. If payments start immediately the total of all payments adds up to $2,466. If the person waits a year and then begins the total of all payments adds up to $2,984 – that is $518 more! This is compound interest working against you big time.
Minimum payments are so low. Another reason people may fail to pay on time is that when the one year runs out they are informed the minimum payment is only about $35 a month. $35 versus $2,420. A hard choice with a cash strapped budget. But if a buyer really wants to pay a lot for this mower and probably still be paying for it when it is time for this mower to be recycled just start making the minimum payments.
FREE DEBT SAMPLES ARE EVERYWHERE
You do not have to drive to Home Depot to get a free debt sample. All you have to do is open your e-mail or your paper mail. (The new national do-not-call list is sort of slowing down the ones that you use to get every evening as you sat down for dinner.) There are plenty of solicitations for new credit cards. A frequent come-on is a zero percent interest for a period of time. This promotional period is usually followed by interest at the maximum the law will allow.
Closely related to the zero percent introductory offer is a zero percent balance transfer. This means, of course, you can transfer your balance from a credit card where you are paying a high rate of interest to a new credit card where you pay zero interest for a period of time.
Once again, from a strictly financial point of view it is hard to argue against the idea of moving from a high rate of interest to zero interest. This would be especially exciting if statistics suggested that the majority of people used this opportunity to reduce and get out of debt. Unfortunately, the majority do not. In fact, it is not uncommon to find that at the end of the zero percent introductory period on the new credit card the balance on that card has risen and the individual is back using the old one again.
I know people who devote enormous time and energy tracking down low cost balance transfer opportunities. They become extremely skilled in moving money around and keeping track of all the dates, interest rates, limits and balances necessary to make this work. I can’t help but think if these same people would use this obvious intelligence and energy and apply it to budgeting, credit discipline and getting out of debt they wouldn’t need to be moving debt around.
DON’T GET TRAPPED IN LONG-TERM DEBT WITH SHORT-TERM RATES.
If you happen to be a balance transfer junkie may I offer this thought? We are going through a period of very low interest rates. This is cyclical phenomenon. It is not permanent. There is nothing in the rulebook that says interest rates can’t go back up. In fact, interest rates are already rising with the improving economy. Soon you will begin to see the zero percent promotions disappear. Transferring will be more expensive. You will then discover you have wandered into the worst financing trap there is – financing long-term debt with short-term interest rates.
Here’s what I mean. If long-term money is borrowed the interest rate remains fixed over the life of the contract, for example an auto loan. The cost of the loan is known and fixed. The rate on short-term financing rises and falls all the time with fluctuations in the marketplace. It may be near 0% today but it might be 5% or 10% or higher in the future. The cost of indebtedness increases with the interest rate.
Technically, credit card debt should not be long-term financing. Credit cards are normally used for short-term disposable items like clothes, gas and entertainment. But in far too many cases the debt in effect becomes long-term financing – long-term financing with a short-term interest rates attached. It becomes long-term because people can’t pay it off. Minimum payments are made and the balance just gets rolled over. I wouldn’t be surprised if half of America still has much of the cost of last year’s Christmas buried in their credit card balances and it is already this year’s Christmas.
Use today’s low rates as a chance to get out of debt. Seriously, if you are a balance transfer artist begin immediately to use your obvious financial skills to get out of debt rather than just moving it around. Today is probably your last best chance to begin.
I must also make a brief comment about another form of debt sample – the 0% APR (Annual Percentage Rate) loan. 0% APR is a popular promotion for things like cars. It is a fact that many people need reliable transportation today and can not pay cash. If a person must finance paying 0% is the best interest rate to pay. My concern is that some people who do not need to borrow decide to sample the debt because it is free. Here’s the deal. Cheap debt is still debt. A person in debt has surrendered some of his freedom and is contractually obligated to a finance company. The borrower’s individual balance sheet has worsened and she has increased her financial risk. Please note that Church leaders have consistently counseled us to stay out of debt. They have not counseled us to stay out of debt – unless it is 0%!
There are more subtle problems with 0% APR financing. Many buyers, unfortunately, buy what their monthly payment qualification will allow not what they need. Low cost financing simply allows them to buy a more expensive toy rather than buying what they need and enjoying a lower monthly payment. It is like eating what is available even if it is more than is needed. Eating more than is needed just because it is available leads to obesity and health problems. Borrowing more than is needed just because it is cheap leads to debt obesity and financial health problems.
Incidentally, 0% APR often is not even cheap. Remember years ago when your dad told you that you could get the car dealer to lower his price if you paid cash? Not anymore. In today’s world there is not much profit for the auto dealer in the car itself. Much of the dealer’s profit comes from getting new owners to finance their vehicles and purchase extended warranties.
However, your dad’s advice still works if you are careful. The dealer may not offer you a discount for cash but the manufacturer may. The manufacturer may offer a rebate instead of 0% APR. A rebate, of course, lowers the price of the car. Financing is not free! Ever! Even in today’s period of low interest rates. Rebates and 0% APR are just marketing promotions offered by the manufacturer. If they are not offering a rebate today hang on awhile, they will.
SOMETIMES FREE SAMPLES CAN LEAD TO SERIOUS ADICTIONS.
Once again I am quick to admit that from a sheer dollars and cents financial view it is hard to argue against some of today’s free debt samples. But I do argue against them. Ask yourself what is in it for the banks and finance companies? These are not benevolent not-for-profit charities. They plan to make money – and they plan to make it off you. I am not against banks or profit. I am against people unwisely getting themselves into a financial mess financed with 0% debt samples. May I make a comparison that many times is more frighteningly accurate than we might want to admit. Over the years I have known a number of people whose lives have been destroyed by drugs. In every case their first sample was given to them free!