The dangers of deferred interest promotions

Bankrate released our most recent retail credit cards survey in October 2023, and the results were shocking. The average retail card APR was a record-high 28.93 percent, which is about eight percentage points higher than the national average for all credit cards. But that’s just the average — some store cards charge as much as 33 percent or more.

What’s even worse is that many retailer-branded credit cards dangle 0 percent promotions that are actually deferred interest offers, which can be very costly if you don’t pay your entire balance before the clock runs out.

That’s right: If you have any remaining balance when the deferred interest period expires — it doesn’t matter if it’s $1 or $1,000 — then the card issuer charges you for all of the interest that would have accumulated, all the way back to the beginning of the term. They do so by multiplying your average daily balance by what’s called your daily periodic rate: essentially, the daily interest rate.

Running the numbers

Here’s an example of how this plays out in the real world. Though it’s hardly the only retailer offering these types of offers, Home Depot often extends deferred interest on its retail cards. The Consumer Credit Card backed by Citi, for example, offers a “6 Months Everyday Financing” promotion on purchases of $299 or more at the time of writing.

The offer states that “Interest will be charged to your account from the purchase date if the purchase balance (including premiums for optional credit insurance) is not paid in full within 6 months,” meaning the interest from that purchase will be deferred, as opposed to not accumulating at all, during that six months. However, I don’t think many consumers fully understand these deferred interest deals.

I’m also concerned by the potential for large purchases to go through this process, since home improvements can be very pricey. Like I said, plenty of retailers offer deferred interest deals. Some other retailers with deferred interest promotions that tend to have larger ticket sizes include Zales, Wayfair and Best Buy, to name a few. But while it’s bad enough that you might owe retroactive interest on a couple hundred bucks you spent at Amazon, it’s quite another if it’s $12,000 in purchases toward a kitchen remodel.

The true cost of deferred interest

Let’s say you decide to take advantage of The Home Depot’s 6 Months Everyday Financing promotion to pay for that $12,000 kitchen rehab. If you fail to pay the entire amount within those six months — again, even if you have a single dollar remaining on your balance — you could be stuck with a massive retroactive interest bill.

The precise amount you’ll owe depends on how quickly you pay off your debt. But for illustration’s sake, let’s assume you intended to make six equal payments of $2,000 but you can only kick in $1,000 during the last month.

In this case, you paid $11,000 out of the $12,000 principal. Yet you won’t just be charged interest on the remaining $1,000 — you’ll be charged on your average daily balance going all the way back to the start of the term at an interest rate somewhere between 17.99 and 29.99 percent.

For this exercise, let’s use the midpoint of that range — or 23.99 percent. By my calculations, you’d owe close to $800 in retroactive interest, even though you paid down more than 90 percent of your balance within the allotted time.

It’s always important to try to pay your credit card bills on time and in full each month. But paying off your bill in full becomes even more important if you’re considering a deferred interest offer. Honestly, even if you’re confident you can pay it off in time, I’d still steer clear. You know the saying about best-laid plans going awry? I would feel better about using an interest-free promotion that’s not phrased as deferred interest.

Alternatives to deferred interest promotions

An alternative is the Wells Fargo ReflectⓇ Card, which offers 0 percent intro APR for 21 months from account opening on both qualifying balance transfers made within 120 days and on new purchases. This is not deferred interest, so if you have a balance remaining at the end of the period, you’re charged interest moving forward on whatever is left, but Wells Fargo won’t go back and charge you retroactively for all of the interest that would have otherwise accumulated. This card’s regular variable APR is 18.24 percent, 24.74 percent or 29.99 percent, depending on your creditworthiness, and the balance transfer fee is 5 percent or $5, whichever is greater.

Other options for financing large purchases include:

• Home equity lines of credit. The average home equity line of credit (HELOC) rate is 9.18 percent, which is nearly 2 percentage points higher than it was in early 2023, but still much lower than most credit cards currently. Be aware that this approach involves putting your home on the line as collateral. The application process can be complicated and involves various fees, too.
• Personal loans. These loans come with an often easier, faster application process than HELOCs. The fact that personal loans are unsecured loans is another plus (but you should still pay the money back, of course). Rates vary widely, from the mid-single digits if you have a strong credit score all the way past 30 percent if you have lower credit. Because the typical term is much shorter than a HELOC, your monthly payments could also be much higher.
• Buy now, pay later plans. Companies such as Affirm, Afterpay and Klarna offer a variety of short-term buy now, pay later payment plans. A classic example is four interest-free payments over six weeks, but sometimes these plans last much longer (up to a few years). The fine print varies tremendously — from 0 percent interest all the way up to around 30 percent — so consider your specific terms carefully.
• Saving up until you can pay for the purchase without going into debt. It may sound old-fashioned, and it may not always be feasible, but it might be the smartest approach of all. You can also consider using a rewards credit card and paying it off right away to earn cash back or travel points.

The bottom line

Deferred interest promotions can be like a wolf in sheep’s clothing. Your supposedly interest-free promotion could end up costing you a lot of money if you fail to knock out the entire balance before the clock expires. Before signing up for one, take the time to fully understand what deferred interest means, since retroactive interest charges can be sizable. Fortunately, there are plenty of payment alternatives, including personal loans, HELOCs and even credit cards with 0 percent introductory APR offers on purchases. Consider checking out one of those cards before going for one with a deferred interest promotion.

Have a question about credit cards? Email me at ted.rossman@bankrate.com and I’d be happy to help.