Deferred Interest: Not Always What You Expect
How You Pay Interest on "No Interest" Loans
It’s nice to get a break on big-ticket items, but advertisements for no-interest credit are not always as good as they sound. To fully take advantage of those offers, you need to be disciplined and understand all of the details.
Unfortunately, you’re up against a system designed to get people to spend more, not less. The terms may be intentionally confusing, making it difficult to enjoy the benefits advertised. By familiarizing yourself with some of the common pitfalls of no-interest deals, you can improve your chances of scoring a low-cost loan.
How Deferred Interest Works
Deferred interest is the most common way that lenders sneak extra charges into so-called no-interest deals. This arrangement allows you to temporarily pay less interest than lenders typically charge. However, you will only pay less interest if you pay off the loan before the promotional period ends. If you miss the deadline, the interest charges will start piling up. You may even be forced to pay the entire interest cost of the original purchase regardless of how much you have paid off up until then.
You can spot deferred interest when you see the term “same as cash” or “no interest for 12 months.” You do have the opportunity to avoid paying interest, but it’s surprisingly difficult to pay nothing in interest. These programs are common when you use a store credit card offer or in-store financing. They’re especially popular for expensive items like jewelry, furniture, and home appliances. You'll notice an influx of these offers around the winter holidays, as retailers entice buyers to spend extra on gifts and pay for them later. Online retailers and their branded credit cards also make these offers.
The Problem With Interest-Free Promotions
An interest-free period is great when you completely pay off your loan on time. But if you don’t, you can easily pay more than you would have paid with a different type of loan. There are several tricks lenders will use to achieve this, as well as environmental factors that could make it difficult to stick to the terms of the loan.
This type of deferred interest is the primary "gotcha" with these deals. If you don’t pay off the entire loan before the deadline, you won't just pay interest on the remaining balance; you pay interest backdated to the first day (and original amount) of your loan. Depending on your loan structure and when you make payments, the charges can be substantial.
If you don't pay close attention to the fine print, you could easily forfeit an interest-free offer. One late payment, for example, and the arrangement could end, forcing you to pay all the interest you were planning to avoid. Retroactive interest charges may be buried deep within the details of your contract.
Most people use deferred interest offers with the expectation that they'll pay off the debt on time, and many pull it off successfully. But life is never 100% predictable. All too often, unwelcome surprises force people to direct funds toward something else, potentially resulting in missed payments on the deferred interest loan. As a result, you could fail to pay off the balance as quickly as expected. A CFPB study showed about 20% of all consumers fail to make the deadline. Among subprime borrowers, less than 50% of borrowers miss the deadline and end up paying deferred interest.
High Interest Rates
These offers typically feature high interest rates (well above 20%) that kick in after the deferred interest period. A borrower may assume they'll pay nothing, so they won't pay attention to the rate after the promotional period. That's fine if they stick to the deadline, but if something goes wrong, those borrowers will quickly realize just how expensive the loan is.
Once a lump-sum deferred interest charge hits your account, you’ll experience sticker shock. Imagine buying jewelry or furniture, diligently paying down the debt, and coming up just a little short at the end of the promotional period. As the promotion ends, you could see another $1,000 (or more) added to your account. These are the retroactive interest charges dumped into your account as a lump sum. To make matters worse, you don't just have to pay off the extra $1,000—the lender can also charge additional interest on your new interest balance until you pay everything off.
0% APR vs. Deferred Interest
Borrowing is always risky because you have to repay it at some point and you can never truly predict your future income or expenses. Despite the underlying risks, some forms of borrowing are safer than others.
A 0% APR offer is not the same as deferred interest. In the past, the terms were confusing, but federal law now makes deferred interest offers easier to spot. With 0% APR, you won't pay any interest for a while, and interest will only start accruing after the promotion ends. If you have a small balance remaining at the end of the promotion, you'll only incur interest on that small amount. That's the opposite of deferred interest loans, which build up a sizable retroactive charge during the promotional period (but you'll only see it added to your account if you miss the deadline).
Lenders can no longer advertise deferred interest as “0% APR” offers. If you see "0% APR," you'll truly avoid interest during the promotional period. If you see terms like “same as cash,” “no interest until,” or “0% interest if paid in full by” a specified date, then you can expect deferred interest on the remaining balance after the end of the promotional period. Also, lenders must show you the exact date that the promotional period ends, and they should show the amount of deferred interest accrued.
Credit Cards With Deferred Interest
When you buy furniture and finance it through a store, the deal is fairly straightforward—you must pay off the balance before the promotional period ends. With credit cards, things get more confusing because you might make a big purchase to take advantage of a no-interest offer, but you might also use the card for additional purchases. If you aren't careful, this can backfire, but you can protect yourself by paying attention to a few key factors.
Credit card companies keep your balances separate based on where the balance comes from. If you borrow at “no interest,” that debt is different from other types of debt like regular purchases and cash advances. If you plan on using a card beyond the original, promotional purchase, pay close attention to where the balance for those purchases end up and what the terms are on that debt.
Where Payments Go
When you make payments, credit card companies are required to apply any payments above your minimum to the debt with the highest interest rate. The only exception is when you’re in the last two months of a deferred interest promotion; then the payments will apply to the promotional balance by default. That means if you aren't at the end of your promotional period, your payments are most likely going toward other balances. This requirement is outlined in the 2009 CARD Act, which is designed to protect consumers, but it works against you in this case. You can ask your card issuer to apply extra payments to your deferred interest balance instead, but you won’t always be successful.
Tips for Borrowers
Avoid surprise interest charges by borrowing wisely and avoiding no-interest loan offers if they include potential pitfalls. Here are a few final tips for anyone considering a no-interest offer.
Watch the End Date
You know that there’s a deadline to pay off the debt, but sometimes that deadline doesn’t make sense. You might expect the deadline to fall on a monthly payment due date, but that isn't always the case. Quirks like these may seem intentionally misleading, but it's the borrower's responsibility to learn them. Lenders win when you fail to meet the deadline, regardless of how confusing that deadline is.
Pay Extra, Early, and Often
It's rarely a good idea to wait until the last minute, especially when your finances are involved. Pay down as much as possible, as quickly as possible. In many cases, the minimum required payment won't pay off your debt before your promotional period ends, so pay extra. The only exception might be a deferred interest credit card with multiple types of debt—you need to crunch some numbers there and learn where your payments are going.
With Credit Cards, Be Careful
Again, payments go to your highest interest rate debt by default. If you have limited funds and you’re trying to pay off a particular balance, ask your card issuer if that’s possible and how to make it happen. Then, every time you make a payment, verify that it goes toward the balances you requested. When in doubt, you can wait until the last two months of your promotional period to make extra payments—those payments should go toward the deferred interest account.
If you have a credit card with a deferred interest balance, avoid using that card for additional purchases. Keeping that balance separate helps you avoid confusion.
Pay your debt entirely at least a few weeks before the end of your promotional period. Doing so gives you a chance to find out if you missed any details (such as unexpected charges that will prevent you from completely paying off your account). If you pay off your debt early and these extra charges appear, you'll still have time to pay them off before the promotional period ends.
Avoid Deferred Interest
If you’re going to pay deferred interest, you might be better off using a different type of financing altogether. Run the numbers and choose what’s best. A flashy promotional offer might not be as beneficial as a traditional source of borrowing. A low-interest rate credit card or personal loan might be less expensive or more consumer-friendly. Better yet, pay cash, and then you'll pay zero interest without any fine print.
Consumer Financial Protection Bureau. "The Consumer Credit Card Market," Pages 164-168. Accessed Nov. 29, 2020.
FTC. "Credit Card Accountability Responsibility and Disclosure Act of 2009," Page 9. Accessed Nov. 29, 2020.