There’s a good chance that if you’ve ever made a major purchase at a retail store, you’ve been offered and maybe even tempted by one of those “No interest for X months!” offers. These types of promotions are commonly offered in connection with furniture, appliances, electronics, automobiles, jewelry and other larger purchases.
Often times, the offer will be described as “zero percent for 12 months” – in some cases even longer. And it’s hard to see the downside. You get that new refrigerator you desperately need, on credit, but without paying any interest for 12 months.
Sounds like a no-brainer, doesn’t it?
Well, there’s a catch.
Just because you aren’t paying interest for the first 12 months, doesn’t mean there isn’t interest quietly accruing the entire time.
How the Offer Really Works
Retailers will defer interest charges during the promotional period. That means that if you repay the entire purchase price during the zero-interest window, you won’t owe any interest. If, however, you don’t repay the entire purchase price by the end of the promotional period, the retailer can charge you interest retroactively on the full purchase price.
Deferred Interest is Usually Capitalized
Most of these promotions will capitalize interest at the end of the promotional period. And that’s a pretty big deal.
Because it means the retailer will tack any accrued interest onto the total amount of the loan after the promotional period comes to an end.
Let me give you an example:
Let’s say that refrigerator you bought on credit had a total purchase price of $1,200. The financing is 20% APR with a zero-interest introductory period of 12 months.
You begin making payments of $100 a month, which puts you on pace to pay the balance before the conclusion of the promotional period. You pay $100 month after month, but because of an emergency you are only able to make a $50 payment on what would’ve been your final installment. Even though your remaining balance at the end of the “interest free” period is just $50, the retailer will tack on $240 in interest dating back to the day you bought the refrigerator.
That’s right, they’ll calculate interest based on the FULL ORIGINAL PURCHASE PRICE, NOT JUST THE OUTSTANDING BALANCE. Now instead of one more payment of $50, you owe $290!
High Interest Rates
To get these types of deals, you usually have to sign up for a store credit card. These store credit cards typically feature interest rates in the neighborhood of 20 to 30%. That’s a lot higher than the average credit card rate which is usually between 14 and 16%.
Simply put, you’ll be on the hook for a hefty interest charge if you don’t pay on time.
What if the Offer is for No Interest and No Payments?
You don’t have to make payments for 12 months and interest is deferred?! Sounds like an even better deal, right?
Maybe. But if you intend to repay the full purchase price before the end of the promotional period, it’s not much different than the “no interest for 12 months” offer. The only advantage is that the “no payment” feature affords you some flexibility when it comes to the amount and timing of your payments.
For most people, it’s the same mousetrap as the other offer but just a little more appealing.
Remember, that interest continues to accrue during the promotional period in most cases. Without a payment schedule to guide repayment, the average consumer doesn’t have the discipline to make payments that aren’t required and will end up owing all of the interest that accrued during the deferment period. (Incidentally, this is similar to what happens when you defer your student loans. The interest accrues during the deferment period and gets added to the loan when it’s time to start repaying.)
Is It Ever a Good Deal?
As a general rule, it’s best to avoid purchasing on credit. But despite the drawbacks, in-store financing can still prove useful in certain situations.
Emergencies happen. Most people don’t have $1,200 tucked away in case of any emergency. And even those who do, might prefer to make interest-free payments rather than depleting their emergency fund.
For those with subprime credit, in-store financing may be the best option available and the only way to make an emergency purchase.
For those with excellent credit, in-store financing can be a good option if the zero-interest period is long enough. This allows the consumer to buy a big-ticket item without completely altering their budget to cover the purchase. That means the consumer can continue investing, paying down other debts, and managing other obligations rather than redirecting significant funds to cover a major expense.
Let’s face it, for most of us a surprise expense that requires a lump-sum payment of more than a thousand dollars is incredibly disruptive. A zero-interest offer can help smooth over what could otherwise be a troublesome situation.
The “zero-interest” offer is only beneficial if you don’t end up paying any interest. To avoid paying interest you must pay off the balance before the deferment period ends. That requires financial discipline. And a plan.
Like any personal finance decision, it’s important to have a game plan so you can make the most of your money. Here’s how I would approach a deferred interest offer:
- Will I be able to pay this off during the zero-interest period?
Before signing up for the promotion and making the purchase, think about what it would take to pay off the total purchase price before the end of the promotion period.
If you have 12 months to pay off that $1,200 refrigerator, that means you need to make payments of $100 a month to pay off the item during the promotion period. I’d want to feel confident that I could make payments of at least $150 a month in order to sign up for the offer. All it takes is a minor bump in the road to throw you off track. And if something bigger comes along, like a job loss, medical emergency, or other unexpected disaster, then your repayment plans can really get derailed.
- How will I make my payments?
There are a couple different ways to make payments. Most people would make their $100 monthly payment to whoever financed the purchase.
Another option is to make payments to yourself. You can do that by putting the monthly payment into a high yield savings account so you earn interest on the money during the “zero interest” period. Just make sure you pay off the entire purchase price before the interest is capitalized and added to your loan. Of course, this option only works if it’s a “no interest, no payments” offer.
If you need to finance, but aren’t sure if you’ll be able to repay the full purchase price during the zero-interest period you might be better off putting the purchase on a major credit card. In fact, you might be able to find a credit card with a zero percent introductory offer. The introductory offer might not be as lengthy as the in-store financing promotional period, but the advantage of the major credit card is that you won’t be charged interest retroactively. Plus, you also have the option of a balance transfer if you end up needing more time to pay it down after the introductory offer expires.
What about an offer for 0% APR?
A 0% APR offer is different than a deferred interest promo. With 0% APR, there really is no interest accruing during the promotional period. That means interest only begins to accrue after the promotion ends (as opposed to getting a large retroactive charge).
It’s important to know which type of offer you are dealing with before you agree to a purchase. You can usually spot the difference by reading the promotional terms carefully. Retailers cannot market deferred interest offer as a “0% APR” product. Instead, they will market them as “same as cash,” “no interest until X,” or “0% interest if paid in full by” a specified time. In addition, lenders must disclose the exact date that the promotional period ends as well as the dollar amount of deferred interest that would have accrued at that time.
A Few Final Thoughts
The biggest problem with deferred interest offers is that the average consumer doesn’t realize what he or she is getting into.
Don’t get caught off guard by retroactive interest charges. Make sure you understand what you’re signing up for!
Once you are confident that you understand the terms of the offer, take your time to make a financial decision that is right for you. Do that by asking yourself if you can afford the purchase and having a well-designed plan in place long before you sign the dotted line.