Why interest rates should matter in your IT purchases

Joseph Anthony is a tax professional in Portland, Ore., who writes about finance and tax issues affecting small businesses. Send Joseph an e-mail.

By Joseph Anthony

A year ago, while looking at new cars, I found something I liked at a price that seemed fair. The dealership closed the sale for me with this line: "Would you like interest-free financing for two years?"

This year, a bank wanted me to transfer some debts to the credit card that the bank had issued me. They sold me on the idea by offering an interest rate of 0% for almost a year on the transfer.

As the saying goes, free is a good price. And other businesses are now taking a page from the automakers' and bank cards' playbooks. Computer manufacturers, software companies, equipment makers, and others are entering the fray with their own "zero-percent" and low-interest offers. (For information on Microsoft Capital Corporation's Total Solution Financing program for technology purchases, see this page.)

0% lives, even while rates rise

What's especially interesting about these offers is that they come at a time when interest rates overall appear to be headed upward. After years of driving down the federal funds' rate until it reached 40-year lows, the Fed began raising rates again in 2004. Mortgage loan rates moved off of the bottoms they reached, and other forms of financing are likewise poised to go higher.

Small and medium-sized businesses, of course, know the importance of being able to borrow to fund information-technology (IT) or other equipment expansions, upgrades and improvements. Prudent borrowing lets you keep access to cash reserves or make a purchase that you simply couldn't buy otherwise. But there is a cost to maintaining that cash flow.

A 36-month, $50,000 loan at 10% interest, for example, could be repaid in equal monthly installments of $1,613.36. The good thing about borrowing the money is that you initially have only a small outlay, and over time you're matching the actual cash outlay for the software, equipment or other asset with the revenues or savings that the purchase helps produce.

But, as I said, there's a cost involved. Over the three years of this example, you would pay $8,080.96 in interest on that $50,000 loan.

A loan tied to the prime rate would be better, of course, costing only about $3,545 in interest if rates were to remain at the 4.5% level of August 2004. But everyone knows that the prime fluctuates and has been reminded that the rate can go up as well as down. Many financial experts feel that rates are destined to move upward in 2005 and 2006. The floating-rate loans that have been so attractive since the start of this decade currently look less appealing.

In this environment, seller-provided interest-free financing is increasingly attractive. In the simplest analysis, it lets a business take money that would otherwise go to debt service and use it for other expenses. Seller-provided financing also can be a simpler way of borrowing than might otherwise be the case for a business, and may even be a source of credit for a business that otherwise might not be able to borrow.

All interest-free deals aren't equal

Zero-percent financing can be a good deal from a tax standpoint as well. You can typically deduct or depreciate some or all of the purchase before you've actually paid for it.

Yet any business considering buying something under a zero-financing program should look at the program as another product to be reviewed and understood. Whether it's a manufacturer lending package, a no-interest credit-card balance transfer offer, or some other promotion, all of these programs have similar features and pitfalls that any business owner should be aware of.

Here are four things to look at when considering zero-percent programs.

That's my idea of a win-win situation — with both wins going into the column of the buyer/borrower.