Have you ever wondered about zero percent financing or deferred-interest plans offered by some retailers?
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If you've made a big purchase in the past few years, chances are you've been offered a deferred-interest plan along the lines of "no interest if paid in full in 12 months." The programs are common in stores that sell high-dollar merchandise such as furniture, electronics and other pricey goods. They're even popping up in doctors' and dentists' offices.
What you may not realize: That offer is probably a credit card, says Chi Chi Wu, staff attorney with the National Consumer Law Center.
Play by the rules, and you get a no-interest loan. However, if you go too late on a payment, misinterpret the payoff date or lose your ability to pay, you could end up with a hefty interest rate plus retroactive interest added to the bill.
"The key thing is that a deferred-interest program is a gamble against time," says Nick Bourke, director of the Pew Charitable Trusts' Safe Credit Cards Project. "The person who uses the deferred-interest offer is betting that they'll be able to pay off the entire balance before the end date."
It pays to ask a few questions and understand the finer points. Here are five things you need to know about deferred-interest credit cards.
Interest Postponed Isn't Necessarily Interest Denied
"This isn't a zero percent loan until the end of the promotional period," says Lauren Bowne, staff attorney for Consumers Union. "The interest is actually accruing, and the bank is just waiving the interest payments."
How the plans work: If you pay the entire loan within a set period of time, the interest is forgiven. That deferment period has to be at least six months, says Wu. The six-month minimum is a requirement under the Credit Card Accountability, Responsibility and Disclosure Act of 2009.
If the balance isn't paid within the deferment period, the interest that's been accumulating is added "in a lump sum" to your balance, says Bowne. Going forward, you pay interest at the preset rate.
"Our research has shown that whereas the median advertised credit card rate might be in the range of 13 (percent) to 21 percent, we will often see deferred-interest programs that have rates of 21 percent and higher," says Bourke.
Because many consumers bank on paying no interest, they are less likely to worry about their interest rates or shop around, says Josh Frank, senior researcher with the Center for Responsible Lending.
Smart move: Run the numbers on that annual percentage rate, or APR, just in case.
It Could Hurt Your Credit
Many times that available line of credit on your new card is equal to the total you're purchasing, Bowne says.
So, in essence, "you're opening up a maxed-out credit card, which doesn't look good on your credit report," she says.
It Can Also Damage Your Credit Score.
Here's why: Your credit score calculates how much of your revolving credit lines you're actually using. For the optimum score, that figure should stay below 10 percent, says Barry Paperno, consumer affairs manager with myFICO.com.
To find out how a zero percent financing offer would affect your credit, determine whether you'd be opening an actual close-ended loan for a set period or a revolving account. Ask how this loan will report to the credit bureaus, says Frank. Will it show up as a credit card or revolving account, or as a close-ended loan?
When you get the answer, consider your own situation. If you're planning a major purchase in the next year, such as a home or car, it might be cheaper to skip opening a new account, pay cash and preserve your credit score.
It's Smart to Consider Your Options
When it comes to future payoff plans, "everyone has the best of intentions," says Wu.
Bowne agrees. "What we've seen over the past few years is that people have every intention and ability to pay off the loan," she says. Then "unexpected things occur, and suddenly they can't make that payment every month."
So weigh the odds. Do you have the money to pay off the purchase in cash now? Can you set it aside, just in case? Is the purchase a want or need? Do you have other payment options?
In some instances, you may even be better off using a low-interest credit card over a deferred-interest plan, says Frank. "There's a higher chance you'll end up paying interest than you think."
Always ask about alternatives, says Wu.
"You don't want to use it for hospital bills," she says. Interest-free medical financing can carry high interest rates when the deferred-interest period expires, and many hospitals offer more reasonable payment plans and other options. And in a few states, alternate payment options are required for eligible patients, she says.
Two Balances Can Add Complications
Sometimes credit cards will allow you to carry two balances — one for the purchases on which you have the deferred-interest arrangement and one for purchases you make later.
What you might not know: Credit card issuers are required, unless you state otherwise, to put anything above the minimum toward the balance without the deferred-interest arrangement, says Wu. The only exception: During the last two months of the deferred-interest period, card issuers have to direct anything above your minimum to the deferred-interest balance, she says.
You only have a set amount of time to pay off your deferred-interest balance. If your payments are going toward the other balance, you're not making any headway.
One solution: If you're carrying two balances on the card, specify in writing how much goes to each when you send in your bill. The law "allows consumers to allocate" their payments, Wu says.
If you do that, follow up regularly, and make sure the money is going exactly where you want it.
Another solution: Don't run two balances when making use of zero percent financing. Until you pay off the deferred-interest balance, don't add to the confusion (and debt) by making more charges. Use a different payment method for new purchases.
It Pays to Understand All the Rules
Leave any of the balance unpaid, and you owe the interest that's accumulated over the last year, not just interest on your current balance, says Bourke. That often surprises consumers, he says.
Additionally, if you make a payment 60 days late, you forfeit your deferment period and zero-percent financing. The new APR could be a penalty rate that's higher than the regular rate that would have kicked in once the deferment period ended, says Wu.
Another point that confuses some consumers: When is that final payment due? Your billing cycle may not coincide with the end of your deferment period. In that case, be on the safe side by using the end of the deferment period as your due date. That date should be displayed on every bill, says Wu.
One solution: Set your own payoff plan to have it paid in full well before the due date, says Kathleen Day, spokeswoman for the Center for Responsible Lending.
Be sure to ask what payment methods are accepted, says Day, or ask to set up automatic payments.
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