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Deferred interest, same as cash: Play the game right or lose

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It sounds too good to be true: Buy now, pay later. However, deferred interest deals offered by big-box retailers, furniture stores, and even online merchants can be tricky, triggering high interest and hefty fees. Consumers who use these deals wisely, though, can save big.

"If you follow the terms to the letter, these can be great deals," says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling, a coalition of agencies that provide financial counseling and debt management. "You can play this game to your advantage."

Consumers who want to benefit from deferred interest deals should be sure to read the terms carefully, make a plan to make timely payments, and stick to it. That's what suburban mom Donna Maria Coles Johnson did when she and her husband bought a house near Asheville, N.C., and needed a new washer and dryer. She went to Sears, spotted a no-interest-for-12-months offer and applied for the store credit card. "I thought $2,500 is a lot to shell out at once, so I just put $1,200 down," Johnson says. "I paid on time and never charged anything else on the card. It worked like a charm."

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How deferred interest works
    Here are examples of how deferred interest works, and how it can cost or save you money.

Here's the deal
Many retailers offer either no interest, period, or no interest and no payments until a certain date -- usually anywhere from six months to a year and a half from the date of sale -- on select items or purchases over a certain dollar amount. Sometimes, Cunningham says, the retailer will pad the price of an item so the store will profit even if the customer follows the terms and ends up paying no interest. "The store just marks the item up, so it's up to the customer to shop around," Cunningham says. "Say 'The guy down the street is selling it for this price -- can you meet it?' or 'This has a dent. Can you mark it down?'"

After getting approved and making the purchase, the customer usually gets a store credit card, issued by a major bank such as Chase or HSBC, and then gets monthly statements. If payments are not required during the interest-free period, the statement will say "no payment due" -- and will sometimes show how much interest is accruing, even though the customer might never have to pay it.

"If it says no payments are due, you should totally disregard that and make some payments," says Linda Sherry, director of national priorities at the national advocacy group Consumer Action. "You should be using this time to pay down the principal."

That's because -- and here's the part that snags many consumers -- if you don't pay the account down to $0 by the required date, which can be a few days or weeks earlier than that promised six months to a year, the credit issuer can charge interest on the full purchase amount for the entire time period. When interest is charged, it's usually much higher than that of a standard credit card -- often between 20 percent and 26 percent. For example, Home Depot's card has a 22.99 percent rate that jumps to a default rate of 26.99 percent if the required minimum payment is not paid and remains unpaid on the following due date, or if a payment check bounces. Best Buy offers two plans with variable interest rates of 20.99 percent or 24.34 percent, with default rates as high as 29.99 percent.

"The highest interest rate I ever saw on one of those deals was like 35 percent," says personal finance expert Steve Rhode, president of Myvesta.org. "The couple didn't pay it off by the due date and got socked with retroactive interest on the whole purchase price for a $3,000 living room set. They were shocked."

In contrast, Rhodes wasn't. "Merchants and lenders are not usually in business to lose money," he says.

Finance experts offer the following
tips for consumers who want to try
making deferred interest deals
work in their favor:
  • Know yourself. "If you pay bills late, if you're a procrastinator, you're not a good candidate for this," says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling.
  • Know that your credit score could take a bit of a hit. "If it shows up as a revolving line that's maxed out, that can hurt your score," says Chi Chi Wu, staff attorney with the National Consumer Law Center.
  • If payments are required, know that one late payment can negate the no-interest deal. Also, payments that arrive too late in the day on the due date might be applied the next day. "Don't push the limit," Cunningham says. "Pay in plenty of time."
  • Call and ask about payment dates. "Call in advance to make absolutely sure when you have to make that last payment by," says Linda Sherry, director of national priorities at Consumer Action. "If you're told one year, it might not really be one year -- it might be 12 billing cycles and that could be earlier."
  • Pay it off early if you can. "To be totally safe, if it was a year, I'd try to pay it in the eleventh month," Sherry says.

Pay attention to the details
The temptation to cave to instant gratification is everywhere. Consumers can use deferred interest offers to buy bricks for a new patio at Home Depot, a new set of dishes at Pier I, a home office fax machine at Office Depot and soon, using the deferred payment service Bill Me Later Inc., even knickknacks on eBay. If consumers don't impose some sort of self control and resistance to these offers, they could end up in big trouble.

First, it's important to read the terms and conditions of any deferred interest deal. These deals vary from store to store. Some retailers require that the customer make minimum payments -- usually a percentage of the balance -- while others allow no payments for a certain time period. The customer must follow the store's requirements carefully in order to keep the no-interest deal. For deals requiring minimum payments, either not making a payment or making it late can negate the no-interest deal; for deals that don't require payments, not paying the entire balance by the required date can do the same and possibly trigger an over-the-limit fee too.

But consumer advocates say even carefully scrutinizing the terms and conditions might not be enough because current rules -- which are in the process of being tweaked by federal regulators as part of an overall effort to protect credit cardholders -- don't require enough disclosure, unlike with, say, mortgages or car loans, where fees are built into the disclosed APR.

"You don't see how much interest you'll pay over the life of the loan, how much your payments will be and how long you're going to be paying," says Chi Chi Wu, staff attorney with the National Consumer Law Center.

Vice President and Senior Counsel for the American Bankers Association Nessa Feddis agrees that clear disclosures are important, but says deferred interest deals give consumers a wider range of buying choices and can also benefit retailers and banks. "It's just one more option," Feddis says. "The consumer gets the choice of having a long-term, interest-free loan, and retailers are always trying to push merchandise out the door, so this is one way to facilitate that."

However, shoppers who do use deferred interest deals shouldn't buy things they can't afford now. "Life is unpredictable, so when you put off an obligation into the future, you're gambling that tomorrow is going to be as good as or better than today," Rhode says. That's what Sheri Rice Bentley, who works at an ad agency, did when she went into a local furniture store in Madison, Wis., and bought an armoire and coffee table to furnish her new condo. "It definitely gave me this false sense of ‘Oh, I can afford $1,000,'" Rice Bentley says. A year later, after many statements had been thrown into the recycle bin, she had to ask her then-fiancé for $600 to avoid an 18 percent interest hit. Rhode warns: "If you're not careful, the thrill of the purchase can override common sense."

See related: Credit card penalty rates: Mistakes that trigger default APRs, Credit card APR disclosure rule change proposed, How credit card APRs work

Published: December 9, 2008



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