Deferred Interest: Not Always What You Expect

How You Pay Interest on "No Interest" Loans

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It’s nice to get a break on big-ticket items, but advertisements for “no interest” charges 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 well-designed system that often gets people to spend more—not less.

How Deferred Interest Works

Deferred interest is an arrangement that allows you to temporarily pay less interest than lenders typically charge. To do so, you must pay off the loan before the promotional period ends. If you miss the deadline, you may have to pay the entire interest cost, regardless of how much you have paid off over time.

How to spot deferred interest: When you see the term “same as cash” or “no interest for 12 months,” you have the opportunity to avoid paying interest. But it’s surprisingly difficult to pay zero interest.

Where to find deferred 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, electronics, and others. Especially around the winter holidays, retailers entice buyers to spend extra and pay later. Online retailers and 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, and lenders employ several tricks to help you fail.

Retroactive charges: If you don’t pay off the loan entirely before the deadline, you pay interest backdated to the first day of your loan. That’s the primary “gotcha” with these deals. Depending on your loan structure and when you make payments, the charges can be substantial.

Technicalities: It’s easy to forfeit an interest-free offer. If you make one late payment, the arrangement ends, and you must pay all the interest you were planning to avoid. If you owe anything at the end of the promotional period—even just a few cents—you still have to pay retroactive interest charges. To successfully take advantage of these offers, you need to be diligent.

Things change: Most people use deferred interest offers expecting to pay off the debt on time, and many pull it off successfully. But life sometimes brings surprises. All too often, that means directing funds toward something else (instead of your deferred interest loan). As a result, you fail to pay off the balance as quickly as expected. A CFPB study showed that 20 percent of all consumers fail to make the deadline (within that group, roughly 43 percent of subprime borrowers get caught and pay interest).

High interest rates: These offers typically feature high interest rates (well above 20 percent). Of course, you assume you’ll pay zero, so the rate doesn’t matter. But if something goes wrong, you’ll quickly realize just how expensive that loan is.

Surprise charges: Once a lump-sum deferred interest charge hits your account, you’ll experience sticker-shock. Imagine buying jewelry or furniture and diligently paying down the debt—but you come up a little short. When the promotional period ends, you could see another $1,000 or more added to your account (the retroactive interest charges). To make matters worse, you don’t just have to pay off the extra $1,000—the lender can charge additional interest on your new interest balance until you pay everything off.

0-Percent APR vs. Deferred Interest

Borrowing is always risky because you have to repay at some point in the future—and you can’t predict your future income or expenses. But some forms of borrowing are safer than others.

A 0-percent 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-percent APR, you can truly pay zero interest for a period of time, and interest will only start accruing after the promotion ends (as opposed to building up a sizeable retroactive charge with deferred interest).

Lenders can no longer advertise deferred interest as “0% APR” offers. Instead, look for terms like “same as cash,” “no interest until,” or “0-percent interest if paid in full by” a specified time. 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, it’s straightforward: You must pay off the balance before the promotional period ends. With credit cards, things get more confusing because you might take advantage of a “no interest” offer and continue using the card for additional purchases.

Here’s what to watch for.

Multiple balances: 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).

Where payments go: When you make payments, credit card companies are required to apply payments above your minimum to the highest-interest-rate debt—unless you’re in the last two months of a deferred interest promotion. That means your payments will most likely go towards other balances. This is a case where federal law (the 2009 CARD Act) designed to protect consumers actually works against you. You can request that your card issuer apply extra payments to your deferred balance instead, but you won’t always be successful.

Tips for Borrowers

To avoid surprise interest charges, borrow wisely, and avoid “no interest” loan offers if they include potential pitfalls.

Watch the end date: You know that there’s a deadline to pay off the debt, but sometimes that deadline doesn’t make sense. The payoff period might be shorter than you expect, and the end date might not fall on the same day as your monthly payment due date. You can debate whether or not this is intentionally confusing. Either way, lenders win when you fail to meet the deadline.

Pay extra, early, and often: It rarely pays to wait until the last minute, especially when your finances are involved. Pay down as much as possible as quickly as possible. The only exception might be a deferred interest credit card with multiple types of debt—you need to crunch some numbers there. The minimum required payment will probably not pay off your debt before your promotional period ends, so pay extra.

With credit cards, be careful: Again, payments go to your highest interest rate debt first. 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 verify that it actually happens the way you want each month. When in doubt, you can wait until the last two months of your promotional period to make extra payments—those payments should go towards the deferred interest account.

Keep it simple: 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.

Finish early: 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).

Avoid deferred interest: If you’re going to pay deferred interest, you might be better off using a different type of financing. Run the numbers and choose what’s best. A low-interest rate credit card or personal loan might be less expensive or more consumer-friendly. Better yet, pay cash, and you can really pay zero interest.