Interest Free and Interest Only: Should We Avoid These Great Offers?
- 8th June 2018
- Posted by: Loanable
- Category: Resources
There are many words that will perk up our ears, and set our eyes bright with joy, and one of those words is FREE.
Another word is INTEREST.
Who wants to pay interest….no one!
So when you combine the words Interest and Free together, you have a sales person’s dream.
On the other hand if you see or hear, 0% or no Interest to be paid, you may experience a slight bit of euphoria as well.
However, these great offers that send chills through our collective financial spines may not be as all they appear to be on the surface. Yes, they can be a great deal, but they are only great deals if used properly and if we exploit the fact we are not paying interest and understand the underlying currents of what the deal means to us.
Did you get all that, good.
“I’m Givin Her All She’s Got Captain”
If you are a fan of Star trek, then you know that reference.
It would seem there are those that feel we are sitting on a “debt time bomb“, which may soon blow. As to where it may blow us, “they” or “those” are unsure, but it could be back to a period over 10 years ago, when we saw the failure of some banks, and the government’s need to bail them out.
We have always had a love/hate relationship with banks, we need them, they need us, yet we both seem to find ourselves in trouble together or a part over the years.
Banks with fraud charges, scandals and mis-selling of various products, PPI being one of those, packaged bank accounts being another.
And us as consumers, borrowers, and some who fail to meet their obligations.
Once we fail to repay a loan we borrowed, that we agreed to the terms and conditions of, we are faced with the threat of having bad credit. Of having our credit scores reduced to mere single digits, and never being able to get credit again.
Blacklisted in the world of borrowing and credit. Only being able to be approved for bad credit loans throughout eternity.
Of course these are just threats, as if we never were allowed to borrow again, banks would be out of business…unless they keep on mis-selling. I cynically digress.
For a long period now, bank and lenders have tried to re-package their wares and products differently to get us in to buy them. In some instances, such as mortgage loans, not much selling had to be done.
If you want to buy a property, in most instances unless you have the cash to buy the house outright, you need a mortgage.
Many people like using credit cards, and with the huge increase in online shopping, credit cards make this form of buying easy, and afford us more protections than using a debit card.
So we are a credit bound society by our very consuming nature.
However, the banks and lenders are clever, and began giving us some offers that were hard to refuse.
Again, if you are going to buy a property, you are usually going to require a mortgage to pay for the property.
You are also going to require a deposit.
So you save up your deposit, toddle off to Mr. Banker and inquire about a mortgage.
If interest rates are high, this will limit or hinder the amount of a mortgage you can qualify for, which means you may need a larger deposit. The higher the interest rate can also increase your monthly mortgage payments.
So Interest-Only Mortgage Loans were created.
You just pay the interest on the loan, which can reduce your monthly payment, allowing you to afford a property, or in some instances, afford a more expensive property as you can afford a higher monthly mortgage payment.
And all was well with the world.
Interest-only mortgages were very popular and in 2007 accounted for one-in-three or almost 40% of all mortgage loans. Today that figure has dropped significantly to around 2% of all mortgage loans.
But there is a catch with these interest-only mortgages, there always is.
At the end of the mortgage term, be that 10 years or whenever, you had to pay off the loan in full. This could be done by re-mortgaging the property, or selling it, if the property had appreciated enough to clear the loan balance.
So in essence, home owners who have interest only mortgages are gambling; gambling they can either pay off the loan through a re-mortgage or some other means.
The first hurdle is will you qualify for the re-mortgage? If not, then selling may be the next option.
Much can change over time, and circumstances change and you may no longer qualify to afford the very home you are now living in.
It is estimated there may be two (2) million home owners facing losing their homes due to having interest only mortgages, and not being able to re-finance or pay off their loans.
Another debt time bomb???
It is thought that there may be as many as 30,000 home owners who are in these types of mortgages, that end in the next two (2) years.
What will occur then???
Some are hopeful the banks and mortgage lenders will come to the aid of those that may be in trouble.
There have been mortgage products in the past in the United States that allow for a stream-line re-finance. It may work that if you are affording your mortgage payments at the current interest rate, even at interest only payments, if the rates drop, or you can show that you have not missed a payment, been late with a payment or in arrears for a period, such as 12 months, 24 months or whatever, the bank will re-mortgage the property for you without the usual and formal being able to prove income and be qualified for the new loan.
The thinking here is, if you paid the higher mortgage payment and did not default, if that payment can be reduced, why would you default then.
Time will tell here.
Zero Interest Credit Cards
Another leader in getting people to take out a credit card, or transfer balances is the low or no interest credit card offers.
These offers are usually limited to 12 months, 18 months, or some time-frame, but are not like diamonds and forever.
Some people will take a few small credit card balances with high interest rates and consolidate those balances onto one low interest or zero interest rate credit card.
These can be great deals, if you use them correctly.
As stated the great offer of 0% ends at a set time, so you have a limited time to just receive that rate, and then the interest rate reverts to whatever the normal interest rate is, which may 19%, or higher, 24% or more.
So any charges or balance transfers on the card need to be paid off in the time-frame.
However, many of us do not do this and don’t pay off the balances during these great low interest periods.
According to RBS, “more than half” of us don’t know when the low rate expires.
If we don’t know when the low interest rate expires, we also may not be aware of what we could end up paying in the end, or our monthly payments may change.
Could this also be a part of a debt time bomb???
Some banks and bankers feel these offers are not the best for customers, and “warn” borrowers may not be aware of what is to come.
The Chief Financial Officer at Royal Bank of Scotland, Ewen Stevenson stated, “We thought it was a bad customer product when we surveyed our customers and over half of them didn’t know the interest rate they were going to be switched into at the end of the zero balance period.”
He adds, “We still think it’s a bad product,’ said Stevenson. “We think at some point, if it’s a bad product, it carries undue conduct risk.”
“That, to us, would be an obvious product to see some intervention on.”
“Call me old fashioned, but I want customers to pay us back.”
“I am objecting to having customers trapped on zero balance and not paying their debts down. I’m objecting to customers getting caught with rates that shocked them at the end of the day.”
This makes sense and seems to be that they are looking out for the best interest of their clients. (pun intended)
The FCA/Financial Conduct Authority believes that “zero percent balance transfers” account for 25% of all credit card debt.
This could be a big debt bomb.
So while words like, “interest-free”, “zero percent interest rate” or 0% look and sound good, we need to be aware of the full ramifications of these nice and friendly sounding words.