Deferred interest postpones interest charges for a certain period of time, allowing you to avoid interest charges as long as you pay off your purchase during the promotional financing period.
You may be offered deferred-interest financing terms with a loan, a line of credit or a credit card. Deferred interest can be either helpful or problematic, depending on how you use it.
Here’s what you need to know when you defer interest on purchases.
How Do Deferred-Interest Charges Work?
Deferred-interest financing does not mean interest-free.
“Deferred interest is when the interest charged on a loan accumulates or accrues and gets added to the principal balance,” says Mike D’Avolio, tax law specialist and staff program manager for Intuit ProConnect Group.
During the promotional period, you’re only required to make the minimum payment, though you’re allowed to pay more than the minimum. You may be offered deferred-interest financing for six months, 12 months or any other time frame the creditor allows.
Interest accumulates at the rate set by the lender. If you pay the balance in full before the deferred-interest period ends, you don’t have to pay the accrued interest.
On the other hand, you’ll pay retroactive interest on the full purchase if you have a balance remaining once the promotional period ends. You’re responsible for paying interest accrued on the entire principal balance from the date you got the financing, regardless of how much of the balance you actually owe.
[Read: Best Home Equity Loans.]
Say you open a $5,000 line of credit to purchase new appliances for a home renovation project. You use the store’s deferred-interest financing option, which has an 18-month promotional period and a 16.99% regular variable annual percentage rate.
At the end of month 18, you still owe $500 toward the original balance. Because you chose to defer interest, the financing company would apply the 16.99% APR to the entire $5,000 purchase rather than the remaining $500.
Deferred-interest financing shouldn’t be confused with zero-interest loans, which also charge no interest during a promotional period. With 0% financing, when the promotional period ends, you pay interest on any remaining balance, rather than on the entire purchase.
Where Can You Get Deferred Interest?
You may encounter deferred-interest plans with credit cards, loans or in-store financing offered by retailers, D’Avolio says.
You also may be offered deferred-interest financing when paying for major expenses, such as home repairs or medical expenses. For example, your dentist may offer deferred-interest plans if you need to pay for orthodontia or surgical treatments.
Deferred interest shouldn’t be confused with deferred payments. For example, you may be offered a deferment on loan payments if you’re facing financial hardship. Depending on the type of loan and the lender’s terms, interest may still accrue during the deferment period.
What Is Deferred Interest on a Credit Card?
Deferred interest on a credit card is common and works much the same way as other types of deferred-interest financing.
You open a credit card and make a purchase. From the moment the purchase is completed, the clock starts ticking on interest accumulation.
You then begin making payments, ideally paying enough to zero out the balance before the deferred-interest period ends. If you don’t, the total amount of interest accrued on the original balance will be applied to your account.
This is different from a credit card that offers a 0% introductory interest rate on purchases or balance transfers. With those cards, you have a promotional period during which you can make payments against the principal but no interest accrues. Once the introductory period ends, you are charged the regular variable APR for purchases or balance transfers based on the remaining balance.
[Read: Best Personal Loans.]
Can Deferred Interest Hurt Your Credit Score?
Deferred interest can affect your credit score. Its effect depends largely on whether creditors complete a hard pull of your credit before approving you and whether the deferred-interest account is reported to the credit bureaus.
If you’re opening a store credit card, for example, the creditor is likely to pull your credit, which could trim a few points from your score temporarily. But if the account is reported on your credit history and you’re making timely payments each month, the account can have a positive effect over the long term.
In-store financing may work differently. The store may only perform a soft pull of your credit, which wouldn’t ding your credit report.
Once the account is open, it may not be reported to the credit bureaus, which means your score wouldn’t be affected. Where you can run into credit score trouble with deferred-interest financing is misjudging your ability to pay the balance in full.
Having a balance when the deferred-interest plan ends can work against you if you can’t keep up with the payments, says Ethan Taub, CEO and founder of personal finance site Goalry. “Late payments can hurt your credit rating tremendously,” he says.
Deferred Interest Pros and Cons
There are some obvious pros — and some equally obvious cons — associated with deferred-interest deals.
On the plus side, Taub says the chief benefit is having time to pay off the balance while avoiding interest charges. Assuming you’re able to pay in full before the promotional period ends, deferred interest can offer some flexibility in managing larger purchases. It may save you money compared with charging the purchase to a high-interest credit card or using a personal loan that must be paid back with interest.
The downside is what happens when the balance isn’t cleared and you have to pay interest charges retroactively. If a deferred-interest plan has a high APR, this could make the purchase much more expensive than you anticipated. People may go into a deferred-interest plan with the best intentions to pay, only to be caught by surprise when they can’t complete the payoff on time.
[Read: Best No-Annual-Fee Credit Cards.]
How to Avoid Paying Deferred Interest
The purpose of using deferred-interest promotional financing is to avoid paying interest. But some strategy may be required on your part to ensure that you don’t do anything to trigger the interest charges.
D’Avolio offers these tips to help keep deferred interest charges at bay:
— Know your due dates. It should go without saying, but pay close attention to the deadline for paying off the balance on your statement. Knowing this due date may help you avoid paying any deferred interest, and it may not coincide with the monthly payment due date.
— Use caution when making multiple deferred-interest purchases. Be careful when you make one purchase on the promotion and another purchase either on or off the promotion, as each balance or loan type is tracked separately. This rule applies if you’re using the same store card or line of credit to make deferred-interest purchases over time.
— Review how payments are processed. If you make payments above the minimum, keep track of how these payments are applied. There are rules that govern which balances the credit card company will apply the payments to if you’re carrying multiple purchase balances.
— Calculate your payoff schedule. Perhaps the most important tip may be knowing what you need to pay to meet the deadline for avoiding interest charges. You can do this by dividing the total balance at purchase by the number of months you have before the deferred-interest period ends. Compare that amount to your budget to make sure it’s realistic.
Last but not least, take your time when comparing deferred-interest financing offers.
Read through all the terms of the financing plan, including the fine print that you might be tempted to skip over. Specifically, look for anything that could cause you to lose your deferred-interest status and make the full amount of interest due, such as paying late. Don’t sign off on deferred-interest terms if there’s something you don’t understand.
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