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Why 0% financing from retailers can be a bad deal

When retailers offer 0% financing
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When retailers offer 0% financing | Scott Olson/Getty Images

When retailers offer 0% financing

If you've recently made a big purchase, chances are you've been offered a deferred-interest plan along the lines of "no interest if paid in full in 12 months." In fact, 0% interest financing has become more popular in recent years, with the number of deferred-financing purchases up by 21% between 2010 and 2013, according to a 2015 study by the Consumer Financial Protection Bureau, or CFPB.

The programs are common in stores that sell high-dollar merchandise such as furniture, electronics and other pricey goods. They're even popping up in doctors' and dentists' offices.

What you may not realize: That offer is probably a credit card, says Chi Chi Wu, staff attorney with the National Consumer Law Center.

Play by the rules, and you get a no-interest loan. However, if you go too late on a payment, misinterpret the payoff date or lose your ability to pay, you could end up with a hefty interest rate, plus retroactive interest added to the bill.

"The key thing is that a deferred-interest program is a gamble against time," says Nick Bourke, director of the Pew Charitable Trusts' small-dollar loans project. "The person who uses the deferred-interest offer is betting that they'll be able to pay off the entire balance before the end date."

It pays to ask a few questions and understand the finer points. Here are 5 things you need to know about deferred-interest credit cards.

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Interest postponed isn't necessarily interest denied | seraficus/E+/Getty Images

Interest postponed isn't necessarily interest denied

"This isn't a 0% loan until the end of the promotional period," says Lauren Bowne, staff attorney for Consumers Union. "The interest is actually accruing, and the bank is just waiving the interest payments."

How the plans work: If you pay the entire loan within a set period of time, the interest is forgiven. Under federal law, that deferment period has to be at least 6 months, says Wu.

If the balance isn't paid within the deferment period, the interest that's been accumulating is added "in a lump sum" to your balance, says Bowne. Going forward, you pay interest at the preset rate.

That can become a huge problem, as the interest rate on deferred-interest credit cards "is generally around 25%," according to the CPFB.

What's more, fewer consumers are paying these loans off during the promotional period, the CPFB found. For 6- and 12-month offers accepted in 2013, cardholders paid off about 75% on time, down from nearly 80% for similar offers originated in 2010.

Consumers with poor credit scores fared worse: Less than half paid their balance off before the end of the promotional period.

Smart move: If you're not sure you can pay off a deferred-interest balance on time, calculate how much it would cost you to finance your purchase using a credit card you already own to learn if that would be a better option.

It could hurt your credit | PhotoAlto/Odilon Dimier/GettyImages

It could hurt your credit

Many times, that available line of credit on your new card is equal to the total you're purchasing, Bowne says.

So, in essence, "you're opening up a maxed-out credit card, which doesn't look good on your credit report," she says.

It can also damage your credit score.

Here's why: One of the key factors that helps determine your credit score is the difference between how much credit has been extended to you versus how much credit you're using. In general, the more of your available credit you use, the lower your score will be.

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To find out how a 0% financing offer would affect your credit, ask the issuer if it will report the account to credit bureaus as a close-ended loan for a set period or a revolving account. Maxing out a revolving loan will have a bigger impact.

When you get the answer, consider your own situation. If you're planning a major purchase in the next year, such as a home or car, it might be cheaper to skip opening a new account, pay cash and preserve your credit score.

It's smart to consider your options | Yuji Sakai/Photodisc/GettyImages

It's smart to consider your options

When it comes to future payoff plans, "everyone has the best of intentions," says Wu.

Bowne agrees. "What we've seen over the past few years is that people have every intention and ability to pay off the loan," she says. Then "unexpected things occur, and suddenly they can't make that payment every month."

So weigh the odds. Do you have the money to pay off the purchase in cash now? Can you set it aside, just in case? Is the purchase a want or need? Do you have other payment options?

Always ask about alternatives, says Wu. Those alternatives include a low-interest credit card or a small personal loan, which may offer interest rates significantly cheaper than what you'd pay if you missed the deadline for eliminating deferred-interest balance.

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"You don't want to use it for hospital bills," Wu says. Interest-free medical financing can carry high interest rates when the deferred-interest period expires, and many hospitals offer more reasonable payment plans and other options. And in a few states, alternate payment options are required for eligible patients, she says.

2 balances can add complications | AtomicImagery/DigitalVision/Getty Images

2 balances can add complications

Sometimes, credit cards will allow you to carry 2 balances -- one for the purchases on which you have the deferred-interest arrangement, and one for purchases you make later.

What you might not know: Credit card issuers are required, unless you state otherwise, to put anything above the minimum toward the balance without the deferred-interest arrangement, says Wu. The only exception: During the last 2 months of the deferred-interest period, card issuers have to direct anything above your minimum to the deferred-interest balance, she says.

You only have a set amount of time to pay off your deferred-interest balance. If your payments are going toward the other balance, you're not making any headway.

The CPFB found that even consumers with good credit scores who carry multiple balances pay off their deferred-interest balance on schedule just 63% of the time.

One solution: Don't run 2 balances when making use of 0% financing. Until you pay off the deferred-interest balance, don't add to the confusion (and debt) by making more charges. Use a different payment method for new purchases.

It pays to understand all the rules | Hailley Howard / EyeEm/Getty Images

It pays to understand all the rules

Leave any of the balance unpaid, and you owe the interest that's accumulated over the last year, not just interest on your current balance, says Bourke. That often surprises consumers, he says.

Additionally, if you make a payment 60 days late, you forfeit your deferment period and 0% financing. The new APR could be a penalty rate that's higher than the regular rate that would have kicked in once the deferment period ended, says Wu.

Another point that confuses some consumers: The final payment due date. Your billing cycle may not coincide with the end of your deferment period. In that case, be on the safe side by using the end of the deferment period as your due date. That date should be displayed on every bill, says Wu.

One solution: Set your own payoff plan to have it paid in full well before the due date.


Editorial Disclaimer: The editorial content is not provided or commissioned by the credit card issuers. Opinions expressed here are author’s alone, not those of the credit card issuers, and have not been reviewed, approved or otherwise endorsed by the credit card issuers.

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