Hosted By: Wyatt Yates
Money Myth: 0% Interest Loans are Free Money
In this episode, we discuss the hidden fees and catches behind these types of debt offerings. What is the biggest hidden fee you are most likely missing? How much is your auto loan costing you over your lifetime? Listen to find out.
1) If you have a 0% interest credit card, pay it off before the interest-free period is up and do not miss a payment.
2) If you have an auto loan, figure out how you can pay it off as quickly as possible. You should be able to pay it off in less than 2 years.
3) Don't fall for the 0% interest or low interest loan hype ever again. Don't use debt to buy depreciating assets.
Wyatt Yates Host 00:00 Money doesn't have to be complicated. You can achieve financial independence. This podcast gets to the truth behind the money mess you hear from your grandma, your broke uncle, the latest social media influencers and the so-called money experts. Welcome to Money Myths with your host, wyatt Yates. 00:23 This week's myth that we're covering is no interest loans are like having free money, or people will say, maybe low interest rate loans are free money. Now, there's two types of loans that typically make up this scenario. You have no interest credit cards, at least for a certain time period, or you have low interest auto loans that you'll see on commercials on TV or online or whatever. Now, to give you an idea on these two types of debts and what it looks like in the US, just to quickly summarize some stats we covered in the last episode in data from the credit reporting agencies, auto loans make up total debt of $1.4 trillion, with an average balance of $19,700, and credit cards make up $836 billion with an average balance of $5300. So that's over $2.2 trillion of consumer debt is outstanding in these two types of loans. Now, the average new car payment is over $500 a month, so it's like $523 per month is the average new car loan payment right now. So as for this myth that no interest loans are like having free money, there is some validity in this statement. Not paying interest, or maybe paying an interest rate that is lower than inflation, is not necessarily bad. It's definitely better than paying high interest or high interest loans. So you can see how it's better than that. So that is some validity in this. But there's a lot of things this myth and this mindset misses. So let's go into why it's false. First, a lot of times these no interest or low interest loans have hidden costs and fees. So let's just look at some examples here as far as hidden costs or fees associated with these loans. 02:37 First let's look at the auto loans. Now, auto loans In the last couple of decades have changed pretty dramatically as far as the manufacturers now have financing arms that are financing the purchase of their cars and they're making a lot of money with their financing side. Ford credit, which is Ford's lending arm, now counts for nearly half of Ford's annual profits. Gm financial, which is GM General Motors lending arm, now counts for nearly 30% of GM's profits. So these financing arms of the main fact car manufacturers is you could make the argument what is keeping them afloat? They're making a lot of money in this and that's why they got into this business as far as the financing side, because it's very profitable arm of their business and it helps keep them afloat in times where they've been really struggling. Now, with the auto loans, the hidden fees and costs include things like loan origination fees, maintenance agreements, etc. 03:52 And very rarely do you actually get the low interest loans that are advertised. Those are kind of a bait and switch. Let's just look at the average interest rate loans by credit score per the credit reporting agencies. So credit score is under 590. Average interest. Auto loan is 50 over 15%. It's 14% interest rate. If your credit score is between 590 and 620, and then 620 to 660, you're just under 10% average interest rate on auto loans for people that have a credit score between 620 and 660. Now let's look at people with the best credit as far as credit score people with credit score over 720. The average interest rate on auto loans is 3.6%. So these are all figures. Above what inflation is these? Yeah, you have good, really good, credit. You can get a lower interest rate, which we all know that, but it's not necessarily these 0% financing that you are seeing on the market now, yes, this looks at all auto loans, so on used cars as well. But this gives you an idea on what people are paying for their auto loans in terms of interest rate, and it's not interest rates less than what inflation is typically or 0%. Most people are paying pretty good interest rates on their auto loans. 05:25 The other factor that's affecting auto loans is the length of the loan. Now it used to be three to five year loan terms were the normal, but it's been increasing over the last several couple decades or so to where now the average loan turn length or loan term on a new car is sitting at 69 months and the average use car loan term is 65 months, and you can get up to 84 month auto loan now for seven years. So what this is producing is what a hidden fee. The longer the loan goes, the more these hidden fees creep in in terms of the higher likelihood you can have negative equity in your car. So your loan could be more than what the car is worth. That is a hidden fee. You're losing money. If you went to sell your car today, if something happened you had to sell your car. You're going to have to pony up the difference between what the car is worth and what the auto loan is. That is a hidden fee, and you know this when you're getting a loan and they offer what they call gap insurance, which this is insurance that they offer to provide coverage for that negative equity. So if they're offering gap insurance, it should be a big red flag that the length of this term, or the, or the interest rate, whatever it is something's making it more likely you're going to have negative equity in this car. 07:06 Another hidden fee that a lot of these auto loans have are prepayment penalties. So if you want to pay it off early, there's a penalty to doing so. Or they may offer you extended warranties above the manufacturer's warranty. Now, a lot of times, this is the dealership that is offering these, but these can also be additional costs. Or they'll offer what they call credit insurance protection, which basically covers your car loan payment in certain situations If you're maybe laid off or disabled, which you should have an emergency fund saved up for this. You don't need to pay for insurance for this. 07:45 These are all a bunch of additional costs that these auto loans throw in there. So, yes, we can look at the interest rate, but once you add in these additional fees, as you know cost for the loan, which is what interest is. Your rates are actually much higher. So there's a lot of stuff that's missed when you think of just the interest rate. You got to look at the total cost of the loan. You can't just look at the interest rate. What are all the other fees and costs associated with that loan? 08:19 And one of the big things that misses is the opportunity cost. So, as I said, beginning, the average new car loan payment is over $500. It's $523. And you, when you're paying that money out, there's an opportunity cost associated with it because you're unable to put that money elsewhere. You're unable to put that money to work for you. A big person that always looks at opportunity costs of basically about everything you read his biography Warren Buffett, one of the richest people in the world, always likes to evaluate what's the opportunity cost of spending, you know, 30 grand on a car versus if I invested that 30,000, what's the difference? And that's your opportunity cost. 09:11 So let's just look at the opportunity cost of your average new car loan, which is over $500 a month in payment. So if you took that monthly payment over a 30 year period, you'd be spending over $180,000 in car payments. So if you're averaging $500 a month for 30 years, that's $180,000 in payments. Let's say you could cut that in half to where you only spent $90,000 on cars over 30 years and you were able to have the other 90,000 to invest. What's the opportunity cost? So at the end of those 30 years you would have. You took that 90,000, you would have $305,000. If you assumed a 7% rate of return, you would have $458,000. If you assumed a 9% rate of return on your money and if you had 11% rate of return on your money, it's $701,000. So the opportunity costs associated with your loan, even if you say we're cutting it in half, is anywhere from $30,000 to $50,000. $300,000 to $700,000 over a 30 year time period. You add in the direct cost. So say what your car loan is costing you at your $500 a month payment of $180,000, your total cost to having that $500 car payment over 30 years is $485,000 to $881,000. You take that over your life. You're talking a million dollar hit on your net worth because you gotta have that car and you have to have that car payment. You gotta have that car that you can't afford to buy outright and have you have that $500 a month car payment. It's costing you a million dollars over your life and that's why the car loan is the payday lender of the middle class. It's stealing your wealth from you. Rich people understand you don't take out loans on depreciating assets. They don't have car loans. 11:24 Now let's look at the credit cards on this myth. As far as interest free loans Cause a lot of the time where you're gonna see this is on credit card offerings. They'll have a window where there's no interest on the card before the interest kicks in. Now this interest free period doesn't always necessarily apply to all types of balances on the card. It may only be for balances that you transferred to the card or for new purchases. So you have to be really careful on what the 0% is getting applied towards, cause it most likely is not gonna be all types of balances on your card. The other thing is, if you don't pay the card off in full by the end of the interest free date or the 0% interest date, typically they will add back all of the interest that would have occurred during the interest free period to the card balance. So there's a big penalty if you don't pay it off during that interest free period and then also, if you fail to make a payment on time, a lot of times they will then add back the interest and say you are no longer eligible for the 0% interest cause you made a payment that wasn't on time. So there's a lot of catches with this 0% on credit cards and you gotta be really careful on where they're at, because a lot of times most people end up paying the interest and that's why the credit card companies do them, because they know on average people aren't gonna meet all the terms of the interest free period to where they're gonna get that interest anyway. Or they're gonna get a new card holder that will eventually rack up the credit card balance and they're gonna get interest. So they're not doing the interest free period because they wanna lose money. They're doing it because they know they'll make money on it. So those are some of the hidden fees, or the truth behind what these low interest loans with credit cards and auto loans really look like. 13:40 But the biggest thing that this myth doesn't understand is that debt robs you of your future income. You're gonna have to pay it all back eventually. The income you have in the future will have to go towards paying this back. Can you predict the future? What happens if your income goes down? If you've fallen hard times for a while, you still have to make the debt payments. You have to take the approach of looking at debt like this it's not, can I afford the payment. It's, I'm signing myself up for future payments in an unknown future where I don't know necessarily how I'm gonna be financially. And why would I Sign up to pay somebody else for X number of months into the future when I'm not even paying myself X number of months into the future? So you have to look at debt that way. You have to understand it's robbing you of your future income. 14:46 If you think that, oh, I can just declare bankruptcy if I get into big of a mess, bankruptcy law is not the same as it used to be 20 years ago. So there in 2005, the bankruptcy abuse prevention and consumer protection act passed by Congress made it a lot harder to qualify for bankruptcy. Less than 1% of people file for bankruptcy in a year in the US, and Most people don't pass the means test. I see this all the time with my clients. They think that maybe I should go through bankruptcy, but it's not gonna. Rarely does it wipe out all your debts Because some of your debts you can't wipe out in bankruptcy anymore. She's got student federal student loans. Those aren't wiped out in bankruptcy and very rarely are you gonna pass this means test To even be able to file for bankruptcy in the bankruptcy courts. It's much harder now, after that 2005 act, than it was 20 years ago. So you have to look at debt this way. It's robbing you of your future income. Look at the opportunity cost. Look at the auto loan example we went through. It's costing you a million dollars in your net worth over your lifetime. That auto loan is that car that important to you? That million dollars could generate 40 to 50 thousand dollars a year in your retirement that you could use to spend and never even touch the million bucks. So I just want to summarize this again and get to our action steps so we can really drive home this, because this mentality or mindset, with this myth, it can really hurt you with your personal finances. So just in summary, this myth fails to look at the hidden cost of these types of loans or Credit cards. The issuers of these types of promotions know they can make money off of this type of bait and switch marketing Technique and that few people will actually qualify or to be able to take advantage of the marketed offer. These companies aren't dumb and they understand consumer behavior better than you. These are big, money-making promotions for the companies that offer them. Even if you do qualify for and are able to take advantage of these promotions, you're still missing the biggest hidden fee of all in your assumption, and that is that you are locking down a portion of your unknown future income to have to repay the debt. The average person in the US is drowning in debt and it's robbing them of their future income. It's restricting what they can and can't do. Like I said last week have a job you hate. You can't leave it because you need the income to pay your creditors. Say you want to start at your own company and not work for the man anymore. You can't do it because you need that steady income to be able to pay your creditors or you don't have enough money to save up to start your own business. So you have to understand this with debt and you got to change your mentality towards debt. I mean, we went through the example with just you're on the auto loan side. It's costing you a million bucks in your net worth when you, by the time you reach retirement, debt is costing you millions of dollars in your net worth, in your financial security, and you have to understand it and look at it differently. Don't look at it as oh, I can afford the monthly payment. So for the action steps this week, let's look at it. The first action step if you have one of these zero percent credit cards, pay it off before the 1% time frame is up and do not miss any payments because they will add the interest back. Now, if you have an auto loan, for action step number two so that number one takes care of the credit cards pay it off before the times up. Number two is your auto loan. Figure out a way. If you have an auto loan, figure out a way to pay it off as quickly as possible. Now most people can do this in less than two years. Lenders put restrictions on how much they're willing to lend you and just by that default, typically I didn't have my clients pay off their car loans in less than two years. If you don't think you can pay it off in less than two years, you need to look at selling it and getting a car you can actually afford, but you can probably keep your car and you can probably have it paid off in less than two years. So that's for the action step number two related to your car loans. And for the third action step is don't fall for this interest free or low interest loan hype ever again. Don't use debt to buy depreciating assets. Wealthy people know this. They don't do it and that's why they're wealthy. So that wraps up our June theme of budgeting, savings and debt. So I covered nine topics between our weekly Friday financial tip email and our blog post, and then the podcast. So we covered nine things related to budgeting, savings and debt. If you missed any of those, please sign up on our website, rugged financial comm, to make sure you're getting those weekly emails and Notifications when a new blog post is is been published. Now for the next month, we're going to be going over home ownership. We're going to be talking about your buying buying a home versus renting. We're going to be talking about insurance, anything associated with home ownership, whether you should use a realtor or not when you're selling or things to look for when you're buying. So Stay tuned for that in the month of July, where we cover home ownership. And, as always, thanks for listening. Please leave a rating review, share the podcast with people you know so we can continue to grow the podcast and continue to help people Reach that financial independence that we all deserve. 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