Article_Zero percent financing—free of cost and interest?

Zero percent financing—free of cost and interest?

Zero percent financing with no interest at all—it sounds tempting, but is it really an interest-free financing option? This is a question asked by many people for whom it is important not to fall into the interest trap. Some sense their chance to grab a bargain and pay it off in small installments. Others hope to finally be able to afford the longed-for item through 0% financing without an interest surcharge. What’s important to you?

For many Muslims, it’s important to adhere to God’s commandment prohibiting interest, which is not only stated in the Quran but also in the Bible and the Torah.

More and more advertisements are enticing potential buyers by stating that they can easily afford their dream product with small installments and no interest as part of zero percent financing. But is that really the case? In this article, we take a look at zero percent financing and explain its features.

What is zero percent financing?

What does zero percent mean, anyway? Linguistically, it means that there is no surcharge on financing. Financing is usually sought when the customer prefers to pay a purchase price in installments. From the customer’s point of view, there are different reasons for and against payment in installments. For the capital provider, financing is always a way to make money. No business offers zero percent financing at zero cost. You should always ask yourself how the company offering zero percent financing makes its money.

Usually, zero percent financing is not offered by the dealer directly but by a bank. Banks’ core business is interest-bearing lending. For banks to earn money from zero percent financing, several options are usually used in combination.

Predefined payment plans with penalty interest

The most important point to remember is that zero percent financing applies only to a predefined payment plan. If installments cannot be serviced or paid, interest on arrears or even penalty interest must be paid. Regular income from penalty interest makes the 0% financing business lucrative for banks.

History: Introduction of interest in Germany

The idea of zero percent financing with penalty interest if installments are not paid on time is nothing new. We already mentioned that the Bible bans interest. Accordingly, there was also a time in Germany when interest-bearing financing was forbidden. The interest ban that prevailed in Germany was gradually relaxed. Lenders argued that they provided an interest-free loan and only charged penalty interest if the agreed installments were not paid on time. This opening toward the interest business led to the interest ban being lifted altogether, even though Luther was opposed to it.

Source: Wikipedia.

Penalty interest is usually collected by means of overdraft facilities. It is not uncommon for overdraft interest to be in the double-digit percentage range. Many people find it difficult to escape this overdraft trap.

One variant of this type of financing is temporary zero percent financing. There is an interest-free phase with a fixed term and installment amount of a few months, for example. After the interest-free period, the interest surcharge is invoiced monthly.

In another variant, a large final installment or balloon installment is agreed. This often cannot be paid all at once and must be financed again. This follow-up financing is then usually not zero percent financing, but a conventional interest-bearing loan agreement.

Therefore, it is important to read contracts carefully and really understand them holistically before regretting signing them. Also, never be afraid to ask questions if you don’t understand something.

Why 0% financing pays off for dealers and banks

For dealers, loan brokerage is worthwhile because banks pay commission for it. Despite the commission payment, it is also a lucrative business for the banks because it saves them the advertising budget needed to attract new customers and retain them with additional services. Often, when the contract is signed, additional credit services such as insurance premiums, hidden additional fees, or further framework loans from the bank are commissioned.

If a payment default occurs, insurance statutes take effect. Here, too, there are many exceptions. This leads to the fact that exactly when you need the insurance, it does not pay. Hidden additional fees could be misleading because they are incurred as part of the loan and are a cost of financing. Thus, it is not zero percent financing but actually an interest surcharge. Another credit service is the conclusion of other framework loans. These are structured, for example, in such a way that the first financing is 0% financing, but each additional financing forms a conventional interest-bearing credit agreement.

Before you take out zero percent financing, always consider the total purchase price. You could buy the same product from another retailer at a lower price if you pay the purchase price all at once. So don’t be distracted by small rates in the advertising.

Source: Verbraucherzentrale (Consumer advice centre)

In Islamic finance, what common ethical financing takes into account God’s prohibition of interest?

The types of financing in Islamic finance (ethical finance) can be divided into two categories: equity-based and debt-based contract models. Both types always have a profit motive.

The equity-based contract models (participation in profit and loss) include:

Musharaka (joint participation/partnership/society with shared opportunities and risks) and
Mudaraba (silent partnership).

The debt-based contract models include:

Murabaha (installment financing, including profit markup) and
Tawarruq (reverse Murabaha).

In Islamic finance, there is only one type of zero-percent financing: Qard Hassan (interest-free financing). In Qard Hassan, there may be no compensation, whether in money or in goods, for granting the loan. The loan amount must be repaid in the same amount. Qard Hassan is charitable financing or financing without the intention of profit.

Sources:

Contractual Models – Islamic Finance, Leila Momen.
Islamic Banking and Islamic Finance, Dietmar Ernst, Bilgehan Akbiyik, and Ali Srour.

Does SUKUUK offer 0% financing?

In SUKUUK crowdfunding (peer-to-peer – P2P finance), the SUKUUK platform is the intermediary between the crowd investors coming from all over the world and you as the homebuyer. To properly respect the rights of all parties involved, a special purpose vehicle (Musharaka) is established. The shareholders are you as the homebuyer and a trust company that represents the interests of all the crowd investors. The crowd investors participate in the financing and have a right over the property. Their shares are rented to you, and the profit from the rental income (Ijara) is their profit. The more shares you acquire, the smaller your rent payment will be in the following month. Once you hold all the shares, you are rent-free and the sole shareholder of your property.

If you find this article useful, share it on social media.

We are continuously working on exciting and informative articles. Subscribe to our newsletter now, and receive valuable knowledge about real estate and money directly to your email inbox on a regular basis.

Would you like to always be informed about new article posts?

Subscribe to our newsletter now

To the article overview