Imagine you are in the market for a new surround sound system. You take a trip to Best Buy and find the ideal surround sound system which will allow you to enjoy your music and movies in crisp, blaring decibel levels. Unfortunately, you don't have the $3,500 in cash to purchase it and your dreams of dinner parties with your favorite album crisply playing in the background are immediately destroyed. You start to exit Best Buy, a deflated version of your former self, when a voice stops you in your tracks. The voice belongs to a Best Buy employee offering credit, absolutely interest free for an allotted time period, to purchase the system. You are elated and immediately jump on the offer, but you shouldn't act so quickly. You were just offered a deferred interest line of credit.
There are some important issues to consider before accepting an offer for a deferred interest line of credit. These deferred interest promotions offer a line of credit, interest free for a specified amount of time. Upon expiration of the promotional time period, if the entire outstanding balance encompassed within the promotion is not paid in full, you will have to pay the piper.
A report published by the National Consumer Law Center (more information and the entire report can be found here) provided that "the two leading providers of deferred interest credit cards are Synchrony Bank (formerly known as G.E. Capital) and Citibank. Both lenders offer deferred interest credit card plans through retailers, such as Walmart, Sears, J.C. Penny, Macy's, Best Buy, Home Depot, and Staples."
The report also compiled the following list of pitfalls associated with deferred interest plans:
Many consumers do not understand that they can be charged interest retroactively for the entire deferred interest period if they do not pay off the balance by the end of the period. The complexity of these plans makes it almost impossible to formulate a short, simple disclosure necessary to prevent consumers from being deceived.
Even consumers who do understand the nature of deferred interest plans can get trapped. Consumers may expect to be able to pay the balance in full by the end of the promotional period, but for a variety of reasons (such as job loss or other financial emergency) find that they cannot. Or, consumers may forget or miscalculate the critical date for payoff, especially if the end of the promotional period does not coincide with the payment due date for that month.
Deferred interest credit cards typically carry very high interest rates, with an average of 24% and as high as 29.99%. These rates can be almost twice as much as the APR for a mainstream, prime credit card, which is typically about 14%.
Balloon interest charges and interest on interest
For consumers hit with deferred interest, those charges come in one big lump sum at the expiration of the promotional period. Interest charges that might have been manageable in small pieces can result in the outstanding balance on a card increasing dramatically. Consumers who cannot pay off that huge interest charge at once then start paying interest on the back interest.
Impact on the most vulnerable
A Consumer Financial Protection Bureau (CFPB) study found that for consumers with subprime credit scores – who are more likely to be financially vulnerable – over 40% were unable to pay off the balance by the end of the deferred interest period. These consumers were likely socked with lump sum retro- active interest charges. In contrast, nearly 90% of superprime consumers avoid getting hit with deferred interest. Thus, better-off consumers get the benefit of interest-free financing, while credit card lenders profit disproportionally from financially constrained consumers.
Minimum payments don't pay off the balance
Lenders generally set the minimum payment as less than the amount that would pay off the balance during the deferred interest period. Thus, consumers who make only the minimum payment – often thinking they are doing what they need to do to avoid interest – will inevitably be hit with retroactively assessed interest at the end of the deferred interest period.
Difficulty allocating payments to successfully avoid retroactive interest
If a consumer makes additional purchases that either do not have deferred interest or have different promotional periods, problems can arise with allocating payments to ensure that the deferred interest balance is paid off. Payment allocation is extremely complex and fraught with pitfalls, and it can be nearly impossible to pay off a deferred interest balance while minimizing interest charges
If utilized properly and carefully monitored, deferred interest lines of credit may be a beneficial financing option. However, consumers should proceed with caution, distinguishing when interest will be deferred on separate charges on the same card and figuring out when the promotion period expires can be confusing, resulting in unanticipated debt.
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