About one in five people who sign up for no-interest deals on big-ticket items actually wind up owing finance charges -- often hundreds of dollars -- because of tripwires in the terms of the credit cards that are used to finance them, industry figures indicate.
Those no-interest deals you see at medical offices or at retailers such as Best Buy and Home Depot can be a boon for buyers who can avoid paying interest on furniture, appliances or other big purchases. But they're an expensive trap for others, consumer advocates say.
"I just don't like them at all," said William Lund, superintendent of Maine's bureau of consumer credit protection. Consumers "don't understand that it's a claw back -- the interest is retroactive."
"No interest if paid in full" the ads shout in large type. The small type tells a different story: Deferred interest actually starts to build up on your store card or medical card the day that you buy the item, but it is delayed until the end of the promotional period -- generally six to 18 months. The interest rates are usually north of 20 percent or 25 percent, which would be penalty territory on a regular card.
Buyers rarely check the rates, since they don't expect to pay interest charges. But avoiding the finance charges is not a sure thing. Fail to pay off the purchase by the deadline or make one late payment, and the card issuer will dump months of back interest on your balance. And if you buy other items with the card, you'll have to track those balances separately from what you owe on the no-interest deal.
Salesmen intent on their commissions are apt to skip over those details when selling big-ticket items, critics say. In fact, the store often gets a share of profits from its cards. Some merchants also get a bounty from the issuer of the store card for each new customer who signs up -- a practice that New York's attorney general said raised conflicts, in his crackdown on a healthcare card.
Popular with buyers
Card issuers say the no-interest offers are popular with consumers who get a sweet deal if they meet all the conditions. Taking many months to pay off a big-screen TV, a bedroom set or dental work without a penny in finance charges can save people hundreds of dollars.
"The deferred financing programs we offer are very popular with our clients' customers, so we do continue to offer a wide swath of these programs," said Alyson Lupo, communications manager for Alliance Data Systems, one of the major issuers of store cards, with about $7 billion in customer balances.
In all, consumers spend more than $150 billion a year using store cards, financial reports indicate. GE Capital, Citibank, Capital One and Alliance Data Systems are the major players in the store card business, with a combined total of roughly $100 billion in outstanding U.S. balances. It's not clear what fraction of that spending is through no-interest deals, but it's a lot. Best Buy alone made sales of about $8.5 billion -- around 19 percent of its total sales -- in fiscal 2013 through deferred interest financing, according to its annual report filed with the Securities and Exchange Commission.
The benefits of the programs have to be weighed against the hardship of people who get smacked with surprise charges. Los Angeles resident Don Haycock is still fighting over interest charges on his no-interest deal from 2009. When he got his hearing tested, the technician told him he needed a $2,495 pair of hearing aids, which he could finance at no interest for one year.
Late payment triggers interest
"He showed me the brochure where it said that -- in 10 minutes, I had credit," Haycock said. A retired attorney who speaks with courtroom precision, Haycock said he understood that the bill needed to be paid in 12 months to avoid interest charges, and he planned regular payments to meet the deadline. But he wound up owing about $284 extra because of a single late payment.
"I was four days late in making the [first] payment," Haycock said. He disputed the charge based on the no-interest promise in the brochure, which did not mention anything about a late payment sinking the deal. When interest continued to build up at a rate near 30 percent, he went to court against card issuer GE Capital. He lost the case, and faced an added penalty on appeal for filing a "vexatious" lawsuit. The card agreement -- not the brochure that Haycock relied on -- stated that a late payment would invalidate the no-interest deal, according to court papers.
Few complaints make it to court, as most store card agreements require customers to go to arbitration with their beef instead. Cases that get around this obstacle face a hurdle bundling claims into a class action. Ohio attorney Shawn Maestle tried to sue Best Buy and Bank One for fraud, on the basis that their card belied its marketing claims when it charged back interest to the date of purchase. But an Ohio appeals court ruled in 2011 that the proposed class of cardholders was too broad to be treated as a group.
Overcoming big price tags
Financing for big-ticket consumer goods has a long history. General Electric Co. got into the financing business back in the 1930s to help people afford its dishwashers and other appliances. Now GE Capital is a major consumer lender and the largest issuer of store cards, with about $34 billion in loans on its U.S. cards in 2012. In recent years, most retailers have partnered with bank cards as their tool for customer financing. In addition to their expertise in loan underwriting, banks enjoy immunity from state usury laws that cap interest rates. Now with medical costs rising, health care items -- such as Haycock's hearing aid -- are increasingly being sold through no-interest financing.
One such deal drew the attention of New York state's attorney general, triggering a rare regulatory crackdown on GE Capital and affiliate CareCredit . More than half of the borrowers applied for the financing while they sat at the doctor's or dentist's office, the probe found. Neither medical providers nor CareCredit's marketing materials adequately explained that patients would pay 26.99 percent interest, built up from the date of purchase, unless they paid off the balance by the end of the deferral period.
"As a result, some consumers incurred substantial debt with costly and unanticipated interest payments and fees," according to settlement papers dated June 3 that were approved by GE's bank unit.
About 25 percent of CareCredit customers who signed up for the deferred interest promotion ended up paying the high-rate finance charges, the probe found, "too often because of the consumer's lack of understanding of what to do to avoid paying interest and general misunderstanding of the terms of financing."
CareCredit also offered medical offices a bounty for signing up card members, creating "unwanted incentives," the settlement papers say. CareCredit ended the practice in 2010, but many retailers such as Best Buy earn a commission for signing up card applicants, or they get a cut of the profits generated from their store cards, SEC filings show.
Some win, some lose
How representative is the 25 percent rate of CareCredit consumers who end up paying interest charges on no-interest deals?
Across GE Capital's store cards, a majority of people who opt for deferred-interest deals succeed in paying off their items in time to avoid finance charges, spokeswoman Cristy Williams said. "Everything in my house that's big has been bought on deferred interest -- I love it," she said.
A sizeable slice of participants are not successful, however. From 10 percent to 30 percent of balances under a no-interest deal wind up owing interest, Williams said. The range covers the company's different retail partners and the no-interest periods available, from six months to 18 months.
Other issuers are less willing to put numbers on the success rates of their customers, but indicated that the range is not out of line. Citibank would only say that a "large majority" of its customers succeed in meeting the terms of deferred-interest deals, putting the figure somewhere over 50 percent.
Capital One and Alliance Data, other major store card issuers, did not respond to questions about the success rate of their cardholders in avoiding interest charges on no-interest promotions.
Store cards have sharply higher interest earnings than regular cards for Citi, one of the few issuers that details the cards' financial performance. Last year, Citi's store cards generated 18 percent interest on outstanding loans, nearly double the interest earned on Citi's general purpose cards.Citi's store cards also had a higher default rate, with late payments beyond the 90-day mark being 73 percent bigger than that of non-store cards, according to Citi's filings for its North American market. However, store card customers have credit quality that is similar to Citi's regular cards, a company spokeswoman said.
Retailers in the crosshairs
During the formulation of the Credit CARD Act of 2009, retailers feared that new rules would put a halt to no-interest financing, as regulators and consumer advocates had grown increasingly critical of the deals. According to a 1996 report from Maryland's attorney general, one unnamed retailer's promotion resulted in half of its customers getting hit by deferred interest.
Retailers lobbied to save the deals, arguing that their sales would suffer and consumers would lose out, too. No-interest deals depend on some consumers paying finance charges, the National Retail Federation argued, since banks won't lend money without any possibility of earning interest. "Consequently, good programs are designed to divide interest expense between those who pay within the deferral period and those who do not," said Mallory Duncan, the retail group's senior counsel in a 2009 statement. Some retailers also subsidize no-interest promotions to help cover the lender's costs, the lobby group said.
As it turned out, the CARD Act and bank regulations in 2010 tightened the rules for no-interest promotions , but allowed the deals to live on. Under the new rules, card holders get at least six months to pay off their purchases. Billing statements must include the deadline, and payments in the last two billing cycles must be devoted to the promotional balance, instead of being absorbed by other purchases that might have been made on the card.
Regulators get another look
Now that new Federal Reserve regulations and the CARD Act are in place, the issue is no longer on the front burner for the retail federation, said J. Craig Shearman, vice president of government affairs. "We probably haven't dealt with it for a few years -- I haven't heard it mentioned," he said.
But a renewed look at the deals may be in the works. The Consumer Financial Protection Bureau began collecting comments about the post-CARD Act environment in December 2012, and consumer advocates took the opportunity to point a critical finger at no-interest financing.
"These programs should be banned; or ... the underwriting requirements should be changed to ensure that consumers are able to pay off these cards before the deferral period ends," Consumers Union said in its filing. The group, the policy arm of Consumer Reports, cited the experiences of card users who were hurt by back interest charges. One Hawaii resident got hit with over $2,000 in interest because she had less than $100 still due on her balance for a $4,800 TV. And a Tennessee man did not realize, until months had gone by, that making his minimum payments would not put him on track to pay off his hearing aid during the deferral period. The minimum payments on store cards are not structured in a way to pay off a no-interest purchase on time.
Consumer problems with no-interest deals did not end with the Credit CARD Act. In fact, one Missouri resident called the consumer protection law a factor in her run-in with a deferred interest promotion.
Danielle Rodabaugh got hit with $247 in back interest on a $1,290 computer, which she thought she had paid off before the 12-month deferral period ended in 2012. Other purchases she had made on the card had added to her balance, and a portion of her payments were absorbed by those balances."Had I not made the additional purchases on the card, I would have paid it off in the amount of time I thought I had," she said via email. In a blog post she attributed part of the problem to the CARD Act, which requires that your payments over the minimum go to the highest-interest balance -- at least until the last two billing cycles of the deferral period.
Her case had a happy ending, as card issuer Barclays agreed to erase the interest after she contacted them and said she would pay off the remaining $544 owed for the computer.
"My takeaway from the situation was that people should always read the fine print," said Rodabaugh, chief operations officer at SuretyBonds.com. "You have no one to blame but yourself -- even though the company stood to gain a lot from my misunderstanding. The fact that they waived the fairly large interest fee, though, shows that they weren't necessarily taking advantage of me."
See related: How deferred interest programs work