F.A.Q. #15: When Does a 5% Interest Loan Beat A 0% Interest Loan?
Updated: Jan 18
It's conventional wisdom that paying a 0% interest loan is the ultimate way to go - particularly for large purchases like automobiles.
And they would be correct. 0% loan interest would beat anything else.
However, not everything is equal at all times.
Let us remember the Four Rules of Financial Institutions:
Financial institutions see lending as THEIR investment. Your cash flow is their investment. You pay interest, or at the very least a regular cash flow @ 0%, to the financial institution. If you interrupt their planned cash flow, they will begin to determine what needs to happen in order to restore their cash flow on their investment.
If something happens to your cash flow and you are unable to make your payments... they will begin to make attempts to restore the cash flow - including retroactive interest costs from the day you began the 0% loan... to repossessing the underlying asset securing the loan under the very real threat of ruining your credit score.
Having bank loans or loans from other financial institutions means that you must meet THEIR terms... or else.
So, what's the solution? There are two ways to go about fixing this:
1) Have enough capital on hand and easily accessible to pay off the loan at any given time. Of course, this would require that you never take out a loan greater than your capacity to pay it off at any given time. This would also mean that you would be giving up any earnings on that capital that you would've earned if you didn't touch it in the first place.
2) Have capital available to borrow against and have more control over the terms. This would be an unstructured loan where YOU have more control over the terms and repayment schedule. You can essentially use your capacity to borrow against yourself, use those proceeds and pay off your obligation to transfer the loan to yourself. You can then make the payments as you can. Yes, this will have an interest cost... but you eliminate the risk of credit score damage AND the threat of repossession.
The reason this works is because the 0% loan is a structured loan by a financial institution. The 5% loan (example rate only) is an unstructured loan against your life insurance policy. This unstructured loan gives you great flexibility, but it does have an interest cost.
However, this only works as long as you don't borrow against your policy more than you could at any time. It's a financial and mental discipline, but that practice would have great peace of mind.
In the event of a cash flow crunch, I'd rather have more control over my lending and other affairs... than remain subject to a lender's terms and conditions.
You can read more about this borrowing strategy here: