The Federal Reserve is pushing interest rates higher. Don’t tell that to people who have become accustomed to buying everything at 0%.
Years of rock-bottom interest rates have led to a proliferation of no-interest financing offers for people looking to buy everything from cars to lawn mowers, jewelry and furniture. Manufacturers and retailers have come to lean heavily on these deals, which are an inducement for shoppers considering large or discretionary purchases.
Now, with interest rates climbing, the cost of these arrangements will rise, pinching profits at companies that derive a large chunk of their sales from shoppers who prefer to pay in bite-size pieces. Most retailers will likely absorb the higher costs to stay competitive because customers may turn elsewhere if they are asked to pony up interest charges.
The cost of providing 0% financing varies from company to company, but generally retailers pay a middleman — usually a bank or finance company — a few percentage points of a product’s purchase price upfront. The practice is known as “buying down the rate to zero” because retailers are in effect footing the financing costs for their customers.
For a shopper buying a $10,000 hot tub with 0% financing over three years, that may translate into the retailer paying a bank or finance company around $1,000 upfront, or around 10% of the purchase price. The consumer then makes monthly payments to the finance company.
The upfront fees retailers pay are often tied to a short-term London interbank offered rate, which tends to rise in tandem with the federal-funds rate. As interest rates climb, banks are likely to increase these fees. The six-month Libor has risen to 1.43% from 0.9% a year ago, according to Bankrate.com, as the fed-funds rate has risen by half a percentage point.
The 0% deals will get more expensive, says Mike Rittler, head of retail card services at TD Bank, which provides no-interest financing to customers of 25 U.S. retailers, including sellers of furniture and tractors. Retailers could limit their costs by providing no-interest financing for shorter terms, he notes.
Companies in many cases say they don’t plan to ditch the offers, which have become a cornerstone of their marketing efforts since the financial crisis. But if profit margins get compressed, analysts say companies may be forced to act.
“Cash has been free for so long that everyone has been able to offer these no-interest deals,” says David Bassuk, a managing director and co-head of the retail practice at consulting firm AlixPartners. “As it becomes more expensive for companies, the game is going to change.”
In general, the longer the no-interest payment term, the higher the cost to the seller. “The offers that were the most generous will become harder to find, because retailers will have to give up more income to provide them,” says Bill McCracken, CEO of Phoenix Synergistics, a consumer research firm.
So far, there are few signs that offers are fading — after all, interest rates, and most companies’ funding costs, remain relatively low. Several retailers say shoppers also have come to expect the deals.
General Motors Co., which has long provided 0% financing for up to 72 months on many new car and truck models, expects to continue the deals. “The beauty of 0% is that it’s pretty easy to understand.” says Jim Cain, a GM spokesman.
In 2002, GM and other auto makers did away with 0% financing deals and moved to other types of sales incentives to woo customers. Roughly a year later, they brought back the deals to counter sluggish sales.
Television shopping network QVC last year started selling a $399 Dyson high-speed hair dryer that many people purchased using a six-month, no-interest installment plan. “The product is a want and a desire, and not a need, and being able to pay in smaller amounts” makes the items more affordable for customers, says Peter Goodnough, QVC’s vice president of Customer Insights & Analytics.
The retailer has no plans to change its offers for no-interest financing. “It would be hard to see a near-term future where the attractiveness of this outweighs the cost of providing it,” Mr. Goodnough adds.
At electronics and furniture chain P.C. Richard & Son, close to a third of shoppers’ purchases are made with store-branded credit cards that automatically let customers pay in interest-free installments, says Chief Financial Officer Tom Pohmer. Shoppers can get 12 to 60 months’ financing on expensive items such as $2,000 mattresses. “The promotions are very important for our customers, and we will offer them when interest rates are high or low,” Mr. Pohmer adds.
Although they acknowledge that rising interest rates will increase their costs, many retailers are hoping the Fed’s rate increase is a sign of an improving economy, which should help their sales grow.
Consumers, meanwhile, can be very sensitive to changes in interest rates. Patrick Williams, senior director of marketing at Jacuzzi Group Worldwide, a Chino Hills, Calif., maker of hot tubs and other bath products, says his company has in the past experimented with 1.99% and 2.99% financing offers, with mixed results. “Consumers have become conditioned to seek out 0% financing,” he says.
In recent years, credit-card issuers also have aggressively used 0% offers to persuade people to transfer their card balances over from rivals.
Of roughly 1.1 billion direct-mail offers for credit cards received by U.S. consumers in the fourth quarter of 2016, some 63% promoted a 0% introductory rate for balance transfers, according to data from Mintel Comperemedia, a market research firm. In the same period two years ago, 73% of the offers had a 0% introductory rate. The decline “has been driven, in part, by the anticipation and subsequent reality of a rising rate environment,” says Andrew Davidson, the firm’s chief insights officer.