Deferred Interest: What You Need To Know
When hunting for a credit card, a loan, or another financing arrangement, you may come across offers advertising “no interest for 12 months” or “same as cash” financing. Take care, because often times, this arrangement will entail deferred interest. Deferred interest financing carries risks that are typically not well understood and often not explained clearly by the lender.
In this article, we’re going to tackle the murky subject of deferred interest.
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What Is Deferred Interest?
Deferred interest is defined by Investopedia in the following way:
Deferred interest is the amount of interest added to the principal balance of a loan when the contractual terms of the loan allow for a scheduled payment to be made that is less than the interest due.
That’s the textbook definition of the deferred interest — interest that has accrued on a loan but hasn’t been paid. But how does deferred interest actually work in the real world? Let’s explore.
How Deferred Interest Works
Let’s say you purchased some exercise equipment with a store credit card offering deferred interest for 12 months in order to avoid having to pay the full cost up front. As the months go by without your balance being paid in full, interest will accrue on your card, but you won’t be responsible for paying it off — yet.
Now, if you pay off your balance within 12 months, this accumulated interest will not come due, and you will have paid for your purchase with what is essentially an interest-free loan. However, if you don’t pay off your purchase in its entirety within that 12 months, all the interest accumulated over that 12-month period (not just the interest on the portion of the balance you have yet to pay) is then added to the amount you owe.
One insidious aspect of this arrangement is that the kind of store credit cards that typically offer deferred interest financing normally have high APRs, thus increasing the interest charges you’ll be hit with if you don’t pay the balance in full within 12 months.
Deferred Interest VS 0% APR Introductory Rate
A credit card offering deferred interest financing under the sophistry of “no interest for 12 months” is not the same thing as a credit card offering an introductory 0% APR. I explained how deferred interest works in this particular context with the above example, but let’s say that instead, you purchased the exercise equipment with a newly-obtained credit card that sports a 12-month intro 0% APR period.
You’ll be able to pay off your balance over the course of your first 12 months without being responsible for any interest payments, just as with the deferred interest card. The difference comes after your first 12 months are up. After this point, you’ll become responsible for any interest that accumulates on the remaining balance of your card, but not for the interest you didn’t pay during your initial 12 months with the card.
If that sounds like a better, fairer, and safer arrangement, that’s because it is.
Pros & Cons of Deferred Interest
If everything goes right and you’re able to pay back the principal of a deferred interest loan in full before the period of deferred interest ends, congratulations! Your deferred interest loan has worked out for you and has not caused you any harm.
However, lenders bank (literally) on the increasingly high likelihood that everything will not go right for you during this period. Americans, particularly working-class families, face constant unexpected financial “challenges” from which they enjoy little to no protection. So if you lose your job or your child gets sick and you can’t pay your balance in full before the end of your deferred interest period, your lender will reap the financial benefits of your misfortune and you will be left high and dry.
Best Practices When Using Deferred Interest
Before signing up for a deferred interest loan or credit card, seek out all possible alternative financing arrangements first. If you’ve exhausted these alternatives and find yourself in the unenviable position of having to rely on a deferred interest loan to pay for an expense, make absolutely sure you can pay off the purchase before the deferred interest period ends to avoid being hit with retroactively-applied interest charges.
Additionally, if you use a deferred interest credit card to finance a purchase, avoid charging anything else to this card if you possibly can. That’s because if you ring up additional charges on your card after your initial purchase, the standard purchase APR may apply to those additional charges, and under the terms of the CARD Act (legislation meant to protect consumers in other contexts), any payments you make on your debt will apply first to these additional charges, not to your initial purchase (the purchase on which the unpaid deferred interest is accumulating). That’s because the CARD Act mandates that when you make a payment on your card greater than the minimum due, the amount beyond the minimum due must be applied to the balance with the highest interest rate first.
So while you might assume that your payments will first apply to your initial balance, this is not the case. To go back to my example, you might think that you’ve paid off that exercise equipment you purchased once you’ve made payments on your card equal to the amount of said purchase. But if you’ve made any subsequent purchases on that card, a portion of what you’ve paid will go towards those balances first, leaving a portion of your initial balance unpaid.
And remember, even if you have just one dollar of that initial purchase left outstanding at the end of your deferred interest period, you’ll become responsible for paying all the interest that has accumulated over 12 months on that entire purchase, not just on that one dollar left unpaid.
In short, if you make a purchase on a deferred interest card, don’t use that card to make any further purchases. It can only get you in trouble.
The parasitic purveyors of deferred interest loans know that the consumers their products are aimed at are overworked, harried, and dealing with an unholy myriad of escalating financial demands — housing, education, health care, etc. These consumers often don’t have the financial literacy required to make sense of deferred interest offers and can easily find themselves hit with large interest charges on purchases they believed to be interest-free, leaving the most vulnerable people in our society open to being fleeced by unscrupulous lenders.
As a result, the cosseted 1% benefits at the expense of the beleaguered 99%. It’s as if a familiar pattern were at play here.
The most direct advice I can give on the subject of deferred interest financial products: Get a traditional credit card with a 0% introductory APR offer instead. Many popular credit cards (both business and personal) are offered with a 0% intro APR period of 9-12 months, though there are other cards offering 15 or even 21-month 0% APR periods. With these cards, you’ll never have to pay retroactive interest, only interest that accumulates on your card’s balance after your 0% APR period ends.
|Credit Card||0% Introductory Period||Next Steps|
|American Express Blue Business Plus||0% APR on purchases and balance transfers for the first 12 months||Compare|
|Chase Ink Business Unlimited||0% APR on purchases for the first 12 months||Compare|
|American Express Blue Business Cash||0% APR on purchases and balance transfers for the first 12 months||Compare|
|Capital One Spark Cash Select For Business||0% APR on purchases for the first 9 months||Compare|
|Bank of America Business Advantage Cash Rewards Mastercard||0% APR on purchases for the first 9 billing cycles||Compare|
If such a credit card appeals to you, let Merchant Maverick help you out in your search!