When 0% Interest Isn't 0%: Credit Card Tricks You Must Know

Single red percent symbol among many dollars
Tim Arbaev
You are about to make a big purchase, and then you are given an amazing offer. Why pay the full amount now, when you can finance the purchase at 0 percent for 12 months? You sign up, and you feel smart.

Before you start feeling too smart, do you know if your 0 percent offer is deferred or waived interest? The difference is huge, and not very well understood.

I regularly receive emails and speak to people who didn't understand the difference and were shocked when a big interest charge appeared on their statement.

Deferred Interest

If you are being offered 0 percent financing by a store, it is likely deferred interest.

Imagine you are shopping at apple.com (AAPL) for a new MacBook. You decide to take the 0 percent for 12 months instant credit offer. The cost is $1,000. (Yes, we know. A new MacBook would cost a bit more. But we're using a round number to make the calculations easy.)

When you take out the deferred interest financing, you are actually opening a credit card. In this case, the credit card is managed by Barclaycard (BCS). The interest rate on that card is a shocking 22.9 percent or 26.9 percent, depending upon your creditworthiness. Lets assume you have excellent credit, so you get the amazing 22.9 percent interest rate.

In the first month, your $1,000 balance would have accrued about $19 worth of interest. That interest is deferred. Barclaycard does not charge you the interest but is tracking that number.

$20 a Month Only Goes So Far

Let's assume that you make $20 payments every month. At the end of the first month, that $20 payment would reduce your balance from $1,000 to $980, because interest is ignored during the deferral period.

Over 12 months, you will make $240 worth of payments, reducing your balance to $760. So far, so good. But by month 12, you have deferred $205 worth of interest.

Guess what happens in month 13? Barclaycard adds $205 to your balance (12 months of deferred interest).

The only way to avoid interest charges is to completely pay off the balance during the 12-month period. So, if you paid $83.33 per month over 12 months, then you would never pay interest. But, if you don't pay off the balance in full before the end of the promotional period, you are charged interest as if you never had a promotional offer at all.

This practice is common with stores. For example, Walmart (WMT) and Home Depot (HD) offer similar deferred interest products (via GE (GE) and Citibank (C)). If you are offered 0 percent financing by a retailer, chances are high that you are being offered deferred interest.

Waived Interest

If you really want interest waived on a purchase, then it is possible. But, you have to do some planning. That is a common theme in banking. If you plan, you can get a good deal. If you react to an offer at the checkout counter, you are likely getting a bad deal.

When a major credit card offers 0 percent on purchases for a set period, it is usually waived interest. For example, Chase Slate (CCF) offers 0 percent on purchases for 15 months. The interest is waived during those months. In month 16, the interest rate will increase from 0 percent to the standard purchase annual percentage rate (which can range from 12.99 percent to 22.99 percent).

Lets assume you decide to finance your Apple purchases. But, instead of saying yes to the offer at the Apple Store, you apply for a Chase Slate card in advance. You then use your Chase Slate to pay for the Apple products.

LIke our previous example, you pay $20 per month. At the end of 15 months, your balance would have reduced to $700.

Here is where you see the difference. In month 16, you will be charged interest on a go-forward basis. Lets assume you have a 22.9 percent interest rate. The charge in month 16 would be about $13 of interest. If Chase were a deferred interest product, the charge in month 16 would have been over $250.

Avoiding a Surprise

If you finance a purchase with a special 0 percent offer, and you pay off that purchase in full before the 0 percent promotion is over, then you will not pay any interest at all. That is the same, whether your interest is waived or deferred.

However, if you don't pay off the balance in full before the promotion is over, there is a huge difference. If you have a deferred interest product, you will be whacked with a massive interest charge after the promotional period is over.

To avoid the deferred interest trap:
  • Only buy what you can afford. If you really need to borrow money to buy that phone at Apple, you probably shouldn't be buying it.
  • If you are trying to be clever (by using 0 percent financing while keeping your money in a savings account), make sure you pay off the balance before the promotional period is over, otherwise you will be made a fool.
  • If you won't be able to pay off a deferred-interest product before the promotional period is over, then think about a balance transfer. To qualify, you will likely need a credit score of at least 700. Just give yourself a full month to get it done. Chase Slate would let you transfer the remaining balance, with no fee, for 15 months. Citibank Simplicity offers 18 months at 0 percent, with a 3 percent fee. At my site -- MagnifyMoney -- we keep an up-to-date list of balance transfer options
But let me be clear. I think deferred interest products are usually terrible deals for consumers. Too many consumers don't understand how the product works, and end up getting hit with big interest charges. In my conversations with salespeople (who try to push the offers), they don't really understand it. either.

The easiest advice: turn down 0 percent financing in stores.

Nick Clements is the co-founder of MagnifyMoney.com, a website that makes it easy to compare and save money on banking products. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the United Kingdom.
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