The Problem With Zero Percent Interest Financing

Velocity banking is a popular approach to paying off debt quickly. Whether it is more effective than making extra payments every month is debatable. You'll see plenty of videos on both sides. However, one thing that velocity banking does well is ensure that you have cash when you need it. This is how I have learned that zero percent interest financing is not always to your advantage.

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It's All About Cash Flow

The reason why velocity banking works is that it frees up cash flow so that you can redirect it to where it will pay down debt the fastest. The trick is to have one debt tool that you can use to pay off the other debts. Often this is a line of credit. By putting your entire paycheck into the line of credit every payday, you bring down your average daily balance. Thus, you reduce your interest cost. Then, as needed, you borrow back out to pay living expenses.

You can search for VIP Financial Education, Denzel Rodriguez, Conanjay Wallace, and other YouTube channels to explain the details of how Velocity Banking works.

Ultimately, whether you actually pay down the debt faster than making extra payments doesn't matter. The greatest benefit of Velocity Banking is that it frees up cash flow so that your budget isn't so tight. VB relies on the flexibility of revolving credit to overcome the rigidity of installment loans.

Making extra payments towards principle may also reduce your interest. However, you are on a tight budget while doing that.

When It's Gone

The problem with installment loans, such as a mortgage, is that you pay the same payment at the beginning as you do at the end. The second problem is that interest payments are front loaded. They are most profitable to the lender at the beginning while your payment mostly goes towards interest, very little going to principal. And, more importantly, once you make the payment, that money is out of your life.

In terms of cash flow, when you make a mortgage payment or car payment, that money is gone, never to be seen again.

On the other hand, if you make a payment to a line of credit, you can reuse that money, if necessary.

Where Zero Percent Interest Works

The problem with debt, particularly large debt, is that the interest payments will make it difficult to pay off. It makes sense to seek promotional financing with zero percent interest. For the most part, this works if you are planning to pay off the whole debt once the promotional period is over. This is good use of cash flow. You are paying a minimum until the promotional rate is over. In the meantime, you can use the majority of your cash for other purposes.

Where Zero Percent Interest Doesn't Work

Where zero percent interest doesn't work is in installment plans. I learned this from my mobile phone plan, which was running at about $250 per month. This was largely due to zero percent interest equipment installment plans for our phones and other devices.

By paying off the equipment installment plans, I am saving $90 per month on my phone service. Now, the monthly bill is $160 per month. That's a savings of $1080 per year in payments.

Even though I was saving on interest payments, I was tying up $90 per month. It is preferable to pay such things on a credit card or other revolving credit. This is because as you pay down the debt, the payment gets smaller and smaller. Whereas on the installment loan, the payment remains the same for the full term.

Installment Loans Are A Trap

If I sold you $1 for $2, you would hesitate to accept the offer, unless you were in extreme need. However, if I sold you $1 over 30 years at 6% interest, you'd be all over it. Although, you'd still be paying me back $2 over the term of the loan. Most 30 year mortgages cost you double what the house cost. This may have lowered, slightly, with the crazy interest rates these days. So, maybe you're buying $1 at $1.50. Still, I can't outright sell you a loan that will cost you 50% without repackaging it so that it sounds more reasonable.

Instead of looking at the interest rate, you should look at the volume of interest you are going to pay over the term of the loan. This will give you a true picture of what the actual percentage is.

In the case of zero percent financing, what you are giving up is control of the payment. The lender sets the term of how long they are willing to finance the purchase. And, they set the amount of the payment. You are locking up cash flow for the length of the loan. This is the trap.

Again, It's About Cash Flow

The main reason why people run into financial problems is because it is so easy to justify large purchases on credit with low monthly payments. A payment here and a payment there. You find yourself with less and less cash to finance living costs. We amortize our freedom.

In some ways, credit cards are preferable debt, if done right. Most people will make a payment and keep money aside to pay for living expenses. The more efficient way is to dump all unencumbered cash into the credit card every payday. This eliminates the monthly minimum and gives you credit for monthly expenses. So long as you are spending less than you earn, that credit card will be paid off without tying up cash. And, you'll pay less in interest because you will have routinely lowered the average daily balance every pay day.

Cash is credit. Credit is cash. If you look at a dollar, it says "reserve note". That means it's a debt instrument. The best debt is debt you can reuse after paying it. The worst debt is debt that locks away cash. This is why zero percent financing can be bad. You may be better served paying some interest on credit you can reuse than paying zero interest on credit that only takes away your cash flow.

For better explanations, do check out YouTube videos on velocity banking.

DeFi Lines of Credit

My interest in this topic is the result of discovering how I can use as a personal line of credit. Unlike traditional lines of credit, or credit cards, there is no banker involved, no paperwork, no credit check, and no payment deadlines.

I've tried velocity banking in the past, only to have my credit lines closed or reduced. This happened, mainly, because of other circumstances. However, it put a halt to the process.

I don't plan on eliminating the use of credit cards. So long as I pay them off in full, they will continue to be useful. Ideally, large purchases that require installments will be run through DeFi credit. Auto insurance, for example, can be paid in annual or six month lumps rather than monthly or bi-monthly. That frees up cash flow. For me, that's an extra $160 every month that is liberated from an inflexible obligation.

The net result is that I'm still paying off debt. The main difference is that it costs less in interest. And, it is on my terms. There are no due dates, late charges, or restrictions. In addition, all of this, despite being on a public blockchain, is invisible to the traditional financial world. It is ironic that my credit rating will shoot up as I move away from the traditional financing system.

The next milestone comes in March 2022. This is when I have some staked crypto getting released. I'll be able to double my DeFi credit line. In addition, I should have made a significant dent in paying down my balance. There is a $235 monthly payment I want to eliminate in March. By November or December, there is a $250 monthly payment I should like to eliminate as well.

So, I've moved up the timeline a bit by paying off my zero interest financing. Be careful with those.

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I'm not sure I agree with you on the mobile phone example. At the end of the day, if you are using revolving credit on which you must pay interest (and revolving credit is usually relatively high interest), then in the long run you will pay more overall then the 0% interest of the phone company. If you really, really need the cash flow it may be an option you need. But if you don't, the 0% interest seems far better.


You are correct that revolving credit interest is relatively high. And, yes, you do end up paying more than with zero percent. I think that if the only debt you have is a zero percent interest loan, you are better off paying that directly rather than through revolving credit. We agree on that.

However, once you combine the zero percent interest with other debt at high interest, such as 20%, then that zero percent isn't helping you. It is slowing you down on paying off the 20% interest debt. This is particularly true if the payment is a rigid installment.

In this case, as a part of the aggregate, the zero percent debt is costing you some interest on the other debt because it's taking you longer to pay that other one.

If the zero percent loan were flexible, allowing you to skip payments or make small payments, then it falls along the lines of what you describe.

As always, it's the details that make the difference. Depending on the situation, zero percent could be beneficial or detrimental.

Good call. Thanks for pointing that out.