By Serena Ng and Vipal Monga
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.
(END) Dow Jones Newswires
March 23, 2017 05:44 ET (09:44 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.