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A zero percent annual percentage rate (APR) means an annual percentage rate of zero, and charges no interest whatsoever. APR differs from the face rate of a loan in that all fees that may be charged to generate the loan are added to the nominal amount of the loan, then amortized over the period of the loan. Fees for origination of a loan are common. Banks can charge fees to credit card holders simply for the privilege of having the credit card. Fees are part of the computation of an APR.
If a seller of goods is offering zero percent APR, he is offering to finance the buyer’s purchase for free. The seller cannot obtain financing for goods for free, so he must be compensated some other way. One way to pay the cost of financing is to add it to the price. If a furniture seller offers a living room set for $3,000 US Dollars (USD) with zero percent APR for three years, a buyer might reasonably calculate a cash price he is willing to pay by subtracting three years of interest from the price. For instance, at an interest rate of 5% per year, the buyer would multiply the $3,000 USD by 0.05, yielding an interest cost of $150 USD per year, which would be $450 USD over three years, making an all cash price of $2,550 USD reasonable.
Zero percent APR is used in the credit card industry to entice people to increase the amount on their credit cards. A credit card holder is offered an interest free loan for a few months, after which interest rates revert to whatever is normal at the time. The bank’s actual hope is that the card holder will be late or go over his credit line, thereby triggering penalties. Many times the penalties are both a fee and a substantial increase in the interest rate charged to the credit card holder. A large fraction of the profits on credit cards comes from late payment and over credit line penalties.
When the consumer is offered zero percent APR, he needs to think carefully about the situation. Free is a very good price, but businesses can’t really afford to offer both the lowest prices and free financing. Banks certainly are not going to offer free use of their money, even for a few months, unless they expect to make more money in the long run than they lose from free financing. A consumer can make good use of the offered zero percent APR if he can save money on something he needs, rather than just purchasing an unneeded item.
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