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Fall 2001

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Buyer Beware:
Watch for Hidden Interest

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Buyer Beware
Watch for Hidden Interest

BY TERRY BRENNER

Mouse trap and financial contract

The newspaper ad reads, “Nothing down, no payment or interest until Jan. 1, 2002.” Sweet deal. You can afford to buy that $500 sofa you spotted a week ago.

But is the deal too sweet? Probably not, if you have no sofa, no credit card and no cash.

On the other hand, if you’re not in a bind quite that stiff, consider this, says Scott Burnham, a University of Montana law professor specializing in consumer law. The sofa you buy for $500 now with no payment due for almost a year is probably a $400 sofa. The $100 difference is the finance charge hidden as part of the cost. In effect, you’re paying 20 percent interest on your purchase to start with. And the deal could get worse, Burnham says.

“The fine print says that if you don’t make that payment on time a year from now, there were finance charges over the year that then become due when you don’t pay,” he says. “So you may owe $700 or $800.”
Most people can’t afford to buy a big-ticket item for cash, so they finance it some other way. Maybe they put it on a credit card, a relatively straightforward transaction. Credit-card companies must clearly state their annual percentage rate charge for credit so buyers aren’t blindsided about the cost of interest.
But maybe they go to a rent-to-own store, get a short-term loan from a payday loan store, write a bad check or postdate a check. These all can have costly drawbacks.

  • Rent-to-own transaction. A buyer doesn’t have the $250 in cash he needs to buy a television set, so he goes to a rent-to-own store. There he sees the same television for $10 a week. At the end of the year he’ll own the set but will have paid $520 for it. The extra $270 amounts to more than 100 percent hidden interest.
  • Payday loan. Stores offering these types of loans charge a high rate of interest even though it may not seem so. Say a buyer took out a two-week loan at a charge of $25 a week. “That doesn’t sound like a lot of money,” Burnham says, “but it may work out to be 200 percent a year. That’s an extremely expensive way to borrow money.”
  • Bad check. The buyer knows his bank balance won’t cover the check but figures his paycheck will reach the bank in time to cover the amount. Caution: Personal checks get to the bank much faster than they once did — two or three days as opposed to a week or two. If the check is bad, the buyer will pay the bank for having written it, Burnham says. And the person or merchant to whom the check was written can collect not only the amount of the check but also a penalty provided by law. “I believe it’s $30 per check,” Burnham says. “And if you don’t pay that, then even worse things can happen,” he says. “There are civil penalties for bad-check writing as well as criminal penalties, so it can cost you a lot to do it.”
  • Postdated check. This can become a bad-check situation because there’s nothing to stop the person who gets the check from depositing it before the date on the check, Burnham says.

Burnham offers another piece of advice about credit: People should shop around for it the same way they shop for the best price on goods. For example, a buyer of a General Motors car should look beyond the in-house finance company for credit.

“Now that we have the Web, you can often search for financing,” he says. “Or go to a bank instead of a finance company.” Don’t rule out a home equity loan, he says. It may be the best value because while tax deductions for most interest payments have been eliminated, home mortgage interest is still deductible.

“So if you could get a 10 percent loan from GMAC or a 10 percent home equity loan from the bank, the home equity loan is going to be cheaper because it’s tax deductible,” he says. “Essentially the bank will write a check to the car dealership, so you’re going to pay the bank for the car instead of paying the dealership.”

Another aspect of credit that warrants a heads-up is credit insurance, Burnham says. If a person buys a car and has to get $10,000 on loan or credit over three years, the person who arranged the financing also may try to sell credit insurance to the buyer. This can be either life or disability insurance that will pay off the $10,000 if something happens to the buyer.

But most banks, credit unions and life insurance companies have term life insurance, which is very inexpensive, Burnham says. Taking out a three-year term life insurance policy for $10,000 would probably cost less than the credit insurance.

“Like everything else, this is something you can shop around for,” he says. “And usually, buying it from the creditor is the most expensive way to buy it.”

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