If you’ve recently made a big purchase, the retailer might have offered you the option to pay over time with a deferred-interest plan along the lines of “no interest if paid in full in 12 months.” What you may not realize – that offer is probably a credit card.
If all goes well, you get a no-interest loan. However, if you’re late on a payment, misinterpret the payoff date or can’t pay, you could end up with a hefty interest rate, plus retroactive interest added to the bill.
Over the past few years, no-interest financing offers have mushroomed, popping up in retailers that sell pricey merchandise like electronics or jewelry. The Consumer Financial Protection Bureau (CFPB) found in 2015 the number of no-interest financing purchases surged by 21 percent between 2010 and 2013.
Is retailer financing a good idea? It pays to ask a few questions and understand the finer points of these types of in-house financing offers. Here are five things you need to know about financing with deferred-interest on your credit cards.
1. Interest postponed doesn’t mean interest-free
The terms of deferred-interest credit cards can be misleading. A typical zero percent interest credit card, for example, is usually tied to a promotional offer where the interest is waived for a period of time. Many people assume that deferred-interest credit cards work the same way.
Deferred-interest financing is not the same thing as interest-free. With a deferred-interest loan, the interest begins to accrue from the beginning of the loan. 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 six months.
You might think you’re getting an interest-free period, but if you miss a payment or pay late, you get penalized with the accumulated interest added retroactively in a lump sum to your balance. And, going forward, you’ll pay interest at the preset rate.
That can quickly increase your debt, as the interest rate on deferred-interest credit cards is generally around 25 percent. Compare that with the average variable rate on traditional credit cards — around 17.86 percent.
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.
2. Your credit could be impacted
When you get a deferred-interest credit card, the line of credit on your card is often equal to the cost of whatever you just purchased. This means you’re opening up a new line of credit and immediately maxing it out.
This can damage your credit score.
Here’s why: One of the key factors that helps determine your credit score is your credit utilization ratio, which 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.
To find out how a zero percent financing offer would affect your credit, see whether the issuer 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 on your credit.
After you find 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.
3. Consider your options
Unless the point-of-sale offer comes with a discount, you’ll be paying exactly the same with retailer financing as you would with cash. And if you don’t make your payments on time, you might end up paying a lot more.
Yes, you may plan to pay off that deferred-interest loan before the promotional period expires, but sometimes life gets in the way. If an unexpected expense keeps you from making your payments on schedule, you could owe additional interest charges.
Consider questions: Do you have the cash to pay off the purchase right away? Can you set funds aside, just in case? Is the purchase a want or need? Do you have other payment options?
A low-interest credit card or a small personal loan may offer interest rates significantly cheaper than what you’d pay if you missed the deadline to pay a deferred-interest balance.
4. Two balances can add complications
Sometimes, credit cards will allow you to carry two balances — one for purchases on which you have a deferred-interest arrangement, and one for purchases you make later.
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 percent of the time.
Don’t run two balances when making use of zero percent 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.
5. Go in understanding all the rules
Don’t agree to a point-of-sale financing offer before you have a good handle on the rules. If you leave any of the balance unpaid past the deadline, for example, you’ll owe the interest that’s accumulated over the last year in addition to the interest on your current balance. That often surprises people who assume they don’t have to pay interest on the portion of the balance they’ve already paid off.
Additionally, if you make a payment 60 days late, you forfeit your deferment period and zero percent 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.
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.
Set a clear balance payoff plan before going with deferred interest on your credit card. This payoff plan, along with a budget will allow you to stay prepared for the unexpected. Also, don’t take alternative payment options off the table, such as cash, a personal loan, a low-interest credit card or a zero-interest credit card.
Don’t fall prey to interest rate payments. Check out Bankrate’s complete catalog on credit card APR advice and learn how to finance your next purchase with a zero-percent introductory rate.