How You Pay Interest on "No Interest" Loans
It’s nice to get a break on big-ticket purchases, but deals with “no interest” charges are not always as good as they sound. Any time you use a deferred interest offer, you’re betting against a well-designed system that often gets you to spend more – not less.
How Deferred Interest Works
Deferred interest is any program that allows you to pay less interest than you’re being charged (at least temporarily).
Most often, you’ll end up with deferred interest when you take advantage of a store credit card offer or in-store financing. When you see the term “same as cash” or “no interest for 12 months,” you have the opportunity to avoid paying interest. As long as you pay off the loan before the promotional period ends, you won’t pay interest, but it’s surprisingly difficult to do so.
Where they’re used: deferred interest arrangements are popular for expensive items like jewelry, furniture, electronics, and more. Especially around the 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 use several tricks to help you fail.
Retroactive charges: The big “gotcha” with these deals is that you’ll have to pay interest backdated to the first day of your loan if you don’t pay off the loan entirely before the deadline. Depending on the structure of your loan and when you make payments, this charge can be substantial.
Technicalities: It’s easy to forfeit the interest-free offer. If you make one late payment, the offer is off the table and you’ll have to pay interest. If you owe anything at the end of the promotional period – even less than a dollar – you’ll still have to pay that retroactive interest. To successfully take advantage of these offers, you really need to be on the ball.
Things change: Most people take these offers expecting to pay off the debt on-time, and many pull it off. But life sometimes brings surprises. All too often, that means directing funds toward something else (instead of your deferred interest loan) and failing to get the loan paid off as quickly as expected. A CFPB study showed that 20% of all consumers fail to make the deadline (within that group, roughly 43% of subprime borrowers get caught and pay interest).
High interest rates: These offers typically feature high interest rates (well above 20%). Of course, you assume you’ll pay zero, so the rate doesn’t matter. When something goes wrong, you’ll suddenly realize just how expensive that loan is.
Surprise charges: Once you get hit with lump-sum deferred interest charges, 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 interest charges). To make matters worse, you don’t just have to pay off the extra $1,000 – you’ll be paying interest on that interest until the debt is wiped out.
0% APR or Deferred Interest?
Borrowing is always risky because you’ll have to repay at some point in the future – and you can never predict your future income. However, some forms of borrowing are safer than others.
A 0% APR offer is not the same thing 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 can truly pay zero interest for a period of time, and interest will start accruing after the promotion ends (as opposed to getting a large retroactive charge).
Deferred interest charges cannot be marketed as “0% APR” products. Instead, you’ll see terms like “same as cash,” “no interest until,” or “0% interest if paid in full by” a specified time. Furthermore, 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, things are fairly simple: you have to pay off the furniture 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 other purchases.
Multiple balances: Credit card companies keep your balances separate. If you borrow at “no interest,” that debt is separate 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” offers if they’re likely to cause problems.
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 date as your monthly payment due date. You can speculate on 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 (unless you have a credit card with multiple types of debt – then you need to crunch some numbers). The minimum 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 does happen). 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 offer, avoid using the card for other purchases if it’s going to cause confusion.
Finish early: Get the debt paid off entirely at least a few weeks before the end of your promotional period. This 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. Better yet, pay cash and you can really pay zero interest.