How Deferred Interest Works and Why You Need to Be Cautious

You need a new washer and dryer. You’ve found the perfect set. And, while you can’t exactly afford to pay the full price out of pocket, your favorite big box appliance retailer has you covered – they’re offering 0% interest for 6 months if you sign up for their special, when-am-I-ever-gonna-use-this-again? store card.

While no one wants you to go without clean hand towels, you may want to take a moment before jumping on this offer. That’s because there’s a good chance you’re looking at a deferred interest promotion, and while that may not be a bad thing on the face of it, it comes with some significant risks.

Deferred interest promotions can be a great way to manage big purchases, but only if you understand what you’re getting yourself into. With that in mind, here’s what you need to know about deferred interest and why you need to be cautious.

How Does Interest Work?

Chances are good you already understand the general idea of interest charges. In short, when you borrow money, your lender will usually charge you a percent of the principle loan amount or credit balance. Interest is how lenders make money and why buying things outright – rather than with credit – is often a better way to go.

Interest is most often expressed as an annual percentage rate (APR). The APR represents the percentage of a balance you’d be charged each year, so (very loosely) a 25% APR on a $1,000 charge would cost you $250 over the course of a year. It’s a bit more complicated than that, however, because interest usually accrues every day. Each month’s worth of interest charges are then added to your balance at the end of each monthly billing period.

In other words, interest adds up. So where does deferred interest come in?

How Does Deferred Interest Work?

The details of a deferred interest promotion will vary, but the general concept is this: during the promotional period, you don’t pay any interest. In fact, if you manage to clear the debt before the promotional period ends, you won’t have to pay any interest at all.

The trick here is that your interest charges aren’t waived, they’re deferred. Each month, you’re still accruing interest. Those charges aren’t being added to your bill, but they’re still out there. And once the promotional period ends – assuming you haven’t paid off your balance in full – all those accrued interest charges will finally show up and be added to your bill. Depending on the terms of the promotion, this may also happen if you miss a payment.

Why You Need to Be Cautious With Deferred Interest

The problem with deferred interest promotions is that consumers are often unclear on exactly what they’re signing up for. A recent study from WalletHub found that 82% of consumers don’t know how deferred interest works.

Because these kinds of promotions are most appealing to consumers who are already working with a tight budget and limited savings, being hit with a significant and unexpected interest charge after six months can be extremely challenging. There’s a reason 81% of the respondents to that WalletHub survey said that deferred interest was “unfair”. No one likes to feel tricked, and most of us can’t afford the kind of costs that show up when deferred interest charges come due.

When to Use Deferred Interest

The biggest issue with deferred interest is that it often misleads consumers into thinking they can afford to make purchases they otherwise wouldn’t make. Deferred interest can be useful – and very valuable – if you understand the terms and, most importantly, pay the balance in full before the promotional period ends.

If you’re feeling enticed by a deferred interest promotion, be sure to follow these steps:

Read the fine print. Make sure you’re clear on what you’re agreeing to and what will happen should you miss a payment or fail to pay the balance before the promotional period ends. You may have to do a little digging – WalletHub found that many retailers don’t exactly make it easy to find all the most important details on these promotions.

Commit to a repayment plan. Ideally, you should review your budget before making any big ticket purchases, but if you’re not feeling quite so ambitious you should at least plot out your path to repayment. At 0% interest, a $1,000 purchase can be paid in full in six months with a monthly payment of around $170. If that’s your plan, commit to it and be ready to make any necessary sacrifices to make it happen.

Make sure you aren’t buying because of the offer. In a competitive marketplace, a deferred interest promotion can be a good way to set a product or service apart from its competitors. As a customer, though, it shouldn’t be the sole determining factor. Make sure you’re treating such offers as a perk or an incentive, but not as the primary reason why you’re buying something. If you wouldn’t buy something without the deferred interest promotion, don’t buy it at all.

Deferred interest promotions can be a helpful way to finally make those important purchases you’ve been dreaming of. Just make sure you understand what you’re getting yourself into.

Jesse Campbell is the Content Manager at MMI, focused on creating and delivering valuable educational materials that help families through everyday and extraordinary financial challenges.

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