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Loan Basics

What Is a No-Interest Loan?

When you're out shopping for a big-ticket item such as furniture or a major appliance, you may be lured by an advertisement for a no-interest loan. With a no-interest loan, you pay back only the money you borrowed—without interest—as long as you closely follow the loan's terms and conditions.

While a no-interest loan may seem like a dream come true, it can quickly steer you toward financial hardship if you're not careful. Let's dive deeper into what a no-interest loan is and whether it may make sense for you.

How Does a No-Interest Loan Work?

Most loans require you to pay back the principal amount plus interest, which is essentially the cost of borrowing money. A no-interest loan, however, allows you to skip the interest charges and solely repay the principal amount. At first glance, this may seem like the ultimate deal. The reality, however, is that certain types of no-interest loans charge deferred interest if you don't follow the loan terms exactly, and that could cost you.

Deferred interest is a delay in interest charges for a set time period. If you pay off your loan balance in full by the end of the no-interest term, you won't pay any interest, deferred or otherwise. In the event you fail to pay off the loan by then, however, you could be on the hook for the retroactive interest charges going back to the day you took out the loan.

Here's how it works.

Let's say you buy $5,000 worth of appliances with a zero-interest loan from the retailer. You have plans to pay it off in full before the time period is up—but you unexpectedly lose your job and don't pay the last $1,000 before the no-interest period ends.

In this case, you'll likely have to pay interest on the entire $5,000 loan, not just the remaining $1,000 balance. And if the standard interest rate is high, your purchase will likely cost you more than it would have if you'd taken out a traditional loan with interest.

What Kind of No-Interest Loans Can I Get?

Here are some types of no-interest loans:

  • Furniture or appliance loans: If you're buying furniture or other costly items for your home, you'll likely come across no-interest loan offers at retail establishments. These loans often charge deferred interest, so if you don't pay off these purchases by the set promotional period, you'll pay interest on the entire amount (and then possibly interest on that deferred interest depending on how long it takes you to pay off the entire amount).
  • Car loans: Some car dealerships entice buyers with no-interest auto loans. A zero-interest auto loan may require a shorter loan period, so you may have higher monthly payments, and you could miss out on incentives such as manufacturer rebates. These secured loans with set monthly payments do not charge deferred interest.
  • Medical loans: Medical care can be expensive, especially if you don't have good insurance or any insurance at all. You may find your doctor participates in a no-interest loan program to help make their care more affordable. Just be sure you know the loan details, as these programs may charge a high interest rate if you don't pay your bill in full by a certain deadline.
  • Nonprofit loans: In an effort to help people who need financial help, some nonprofit organizations offer no-interest loans. But you could fall into the same trap of owing interest and other charges if you don't pay back the loan on time.

Do I Need a Good Credit Score for a No-Interest Loan?

The lender and type of no-interest loan you're interested in will dictate whether or not you need a good credit score. If you're hoping for a no-interest auto loan, for example, know that car dealerships require good to excellent credit.

No-interest auto loans and other types of no-interest loans aren't usually an option for people with poor or average credit. Sometimes, however, you may find a no-interest loan that doesn't require a credit check. While this is rare, these types of offers do exist.

Are No-Interest Loans a Good Idea?

A no-interest loan may be a good option if you are confident you can repay your balance in full by the end of the no-interest period. If you go this route, keep these tips in mind:

  • Read all of the fine print carefully so you are aware of the interest rules and any additional fees you could face.
  • Ask the lender any questions you may have regarding the loan and its terms before you sign the application.
  • Make it a priority to make every payment on time and in full.
  • Don't overspend, as the 0% interest rate is only temporary.

Avoid no-interest loans if you're not sure whether you'll be able to pay off your loan in time to avoid interest. By taking one out when you have many high expenses in the near future, you can trap yourself in a cycle of debt.

Remember, it's easier to stay out of debt than get out of it. Don't think you can repay your balance on time and avoid interest? You're likely better off with a traditional loan where you pay principal and interest charges from the get-go and have a set repayment period.

Consider Your Lifestyle and Financial Situation

If lenders didn't make any money on zero-interest loans, they wouldn't offer them. These types of offers are quite profitable for them for the obvious reason: Many customers can't make complete their payments by the set deadline and end up paying exorbitant interest charges.

So before you take the plunge and agree to a zero-interest offer, take a close look at your budget and lifestyle needs. Are you able to meet the requirements necessary to maintain a 0% interest rate? If not, consider an alternative financing option that is less likely to put you in more debt than you originally anticipated.