A friend of mine recently did the math on a consumer financing “deal” offered by Future Shop:
The flyer advertises “No Payments, No Interest” for a period up to 18 months. The fine print at the back explains that there is a graduated “administration fee” that increases depending on the length of the “no interest” term. For a $299 purchase utilising the 18 month “No Payments, No Interest” option, the Administration Fee is $99.99. Funny enough, annualized, that is equivalent to more than 22% interest/year. This gets better.
Statistically speaking, nearly 9 out of 10 people who use these programs do not pay their entire balance off in the term allowed. This lets the finance company add on the interest owing, calculated from when the agreement started (18 months ago) at their rate of 29.9% per year. On that $299 purchase, the interest owing would be an additional $134.10 at the 18 month and 1 day mark.
That all means that at the 18 month and 1 day mark, which between 80-90% of people reach, the interest and fees on a $299 purchase would be $99.99 + $134.10 = $234.09 bringing the total purchase to $533.09. The total realized interest works out to 78.29% of the original purchase, or annualized, 52.19% per year.
That’s absolutely staggering. More so is the number of people who will go in for these shenanigans thinking that somehow they’re getting the better end of this deal than the store. One, stores aren’t that charitable, and, two, I highly doubt that people would get such a clear and concise explanation in the store if they asked for it. What these “deals” reflect is the advantage organizations take on consumers due to the underlying lack of credit and financial education that people have. Think about it, if everyone took the time to do the math, payday loan organizations and in-store financing arms would be out of business.
How do we fix this? For starters, current consumers need to be educated on the different types of credit, how each type works, what their credit score is, and how a consumer’s behaviour affects their credit score. Then, future consumers (i.e. kids) need to receive the same education about how to manage and use credit effectively as well as proper financial planning. When you boil it down, credit management and financial planning aren’t rocket science but they are lessons that need to be taught and re-enforced throughout a person’s K-12 schooling, the same as other core subjects. You can’t touch on them in one ironically-named “Career and Life Management” class that runs for an hour every other day over three months in high school and expect kids will be setup for success. They won’t and it’s clearly evident by how many people carry crippling debt loads or find themselves filing for bankruptcy. The first step to financial freedom is education.
The next course of action – and I’m sure my friend will crucify me for suggesting this – is to regulate credit interest rates and curb predatory practices. Yes, it protects ignorant consumers but is the morally correct decision to alleviate the financial stress too many people find themselves under. Let’s look at the average person in Canada who is 20+ years-old and has $16,400 (as of July 2010) of unsecured debt (i.e. debt that isn’t a mortgage or loan secured by physical property). The difference in annual interest between a credit card with a 28.5% annual rate and a line of credit with a 5% annual rate is $3,854.00 ($4,674.00 interest for the credit card and $820.00 interest for the line of credit, assuming you only pay the interest and don’t add to the principal). A person could pay off that $16,400 of debt in 4 years with the interest savings alone between the two credit products.
Ultimately, though, it comes back to consumer education; no amount of legislation can prevent people from making poor decisions. So, please educate yourself about types of credit, request your credit score and report from Equifax or TransUnion, learn how your credit usage affects that score, look at switching credit products, talk to your financial institution and/or credit-card issuing organization, read about credit management and financial planning, talk to credit coaches and financial planners, and – most importantly – talk to and educate one another. People can be successful in discussing credit alternatives and strategies without crossing into the taboo subject of personal financial situations, they just need to know where to start.