Weighing Up The Pros and Cons...
Interest-free credit offers can be enticing, especially when purchasing big-ticket items like a kitchen. However, beneath the allure lies a complex interplay of costs and benefits for both the retailer and the customer. In this blog post, we’ll delve into the pros and cons of interest-free credit for kitchen purchases, considering its implications for the retailer’s costs, the customer’s expenses, and credit utilisation.
Pros of Interest-Free Credit:
Affordability: Interest-free credit allows customers to spread the cost of a kitchen over time without incurring additional interest charges. This can make high-priced items more affordable and accessible to a broader range of consumers.
Convenience: By offering interest-free credit, retailers provide customers with the convenience of flexible payment options. This can be particularly appealing for those who prefer to manage their finances through installment payments rather than a lump sum.
Increased Sales: Interest-free credit promotions often attract more customers and stimulate higher spending. The psychological effect of not having to pay interest can incentivise consumers to make larger purchases, boosting sales for the retailer.
Cons of Interest-Free Credit:
Cost to Retailer: While interest-free credit may attract more customers, it comes at a cost to the retailer. Typically, the retailer pays a fee to the financing company, which can range from 5% to 10% of the transaction amount. In the example provided, if the retailer offers interest-free credit but still has to pay VAT on the full purchase price, it further eats into their profit margin.
Potential Losses: There’s a risk that some customers may default on their payments, leading to losses for the retailer. Even though the retailer receives a reduced amount upfront through the financing company, they are still liable for the full cost of the product.
Impact on Credit Utilisation: Utilising interest-free credit for a kitchen purchase can impact a customer’s overall credit utilisation ratio. While not directly accruing interest, the outstanding balance on the interest-free credit is still considered in calculating this ratio, which could affect credit scores.
Retailer Cost Calculation: Let’s break down the expenses incurred by the retailer when offering interest-free credit, using the provided example. If the retailer receives £900 instead of the full £1000 due to a 10% fee, yet is still required to pay VAT on the full £1000, the actual cost to the retailer is calculated as follows:
Retailer Cost = £1000 (Product Cost) + 20% VAT – £1080 (Received from financing company) = £1200 – £1080 = £120
Hence, the retailer bears a cost of £120 for offering interest-free credit per £1000 of kitchen purchase, amounting to 12%. Now, since the prices of appliances and quartz work surfaces are fixed and readily available online, any increase in cost must be absorbed by the furniture component of the package. This necessitates a roughly 20% increase in the cost of furniture to offset the overall expense of interest-free credit for the entire kitchen. If a company is unable to implement a 20% price hike to cover the additional cost, the difference must be compensated for through the quality of the furniture.
Opting out of the interest-free offer and paying by cash or personal credit card does not exempt one from bearing the cost of interest-free credit, as it is factored into the overall purchase price of the kitchen. Furthermore, according to regulations, retailers are prohibited from offering additional discounts for cash payments, as this would render the interest-free credit chargeable.
Conclusion:
Interest-free credit can be a double-edged sword for both retailers and customers when purchasing a kitchen. While it offers affordability and convenience to customers, it comes with costs and risks for retailers, impacting their profit margins and potentially leading to losses. Customers should weigh the benefits against the potential impact on their credit utilisation, and ultimately the quality of the actual kitchen furniture they purchase, and retailers should carefully consider the financial implications before offering interest-free credit options. Ultimately, transparency and informed decision-making are key to navigating the complexities of interest-free credit in the realm of kitchen purchases.
