What is Deferred Interest?
Deferred interest is a concept that describes a particular feature of a repayment system either on a loan or credit card purchase. It is typically an incentive to make a purchase or take out a loan because it allows you to defer your interest payments to a future date if you are unable to pay back the amount in full before the deferred interest period expires. Otherwise, you benefit from what amounts to a zero percent interest loan.
How does deferred interest work?
Most of us are probably familiar with federal student loans and what it means to have a subsidized student loan versus an unsubsidized one. Similar to an unsubsidized loan, interest begins accruing at the moment you withdraw your loan money. With deferred interest, however, you are given a certain period of time to make payments on a purchase or loan, and if you pay off the balance in its entirety by the end of the “no interest” period, you do not owe any money in interest. In this way, deferred interest operates like a subsidized loan, in that you have essentially borrowed money with a zero percent interest rate. But if you fail to repay the total amount in the time allotted, you must repay the interest retroactively applied to every previous payment.
For example, many companies with big-ticket items will offer deferred interest to increase their chances that you’ll make a purchase through their store despite not having the money to pay off the item the day you buy it. In these cases, you are required to finance the cost of the item you purchased through either a loan from the business or a store credit card. So if you plan to finance a Peloton bike that costs $2,500 over a deferred interest period of three years, you would owe about $69.44 each month for thirty-six months.
As long as you make your nearly seventy dollars payment on time each month for those three years, you would have paid off your Peloton without having to pay any interest on your financing. Should you miss a payment, make too many late payments, or fail to repay the entire amount altogether by the end of those three years, however, you would be responsible for the interest on the cost of the bike ($2,500) and not just your remaining balance.
What is the difference between deferred interest and zero percent APR?
When it comes to credit cards, a zero percent annual percentage rate (APR) implies that you accrue no interest for the prescribed period. For some credit cards, it can be as long as a year and a half in which you would be able to make purchases, pay the minimum monthly payment, and never be charged any interest for goods and services bought during those eighteen months. You can also use zero percent interest credit cards to pay off high-interest rate debts that you owe, benefiting from the zero percent interest period in which you’d have time to pay off your debt month-by-month without additional interest.
Deferred interest is different from zero percent APR credit cards because the interest accrues during the “zero percent interest” period, and you only avoid paying for it by repaying the entire amount of your loan or credit purchase before the repayment period ends. If you do pay off the whole amount before the period ends, your experience would be nearly identical to repaying a purchase made on a zero percent APR credit card.
Will deferred interest ruin my credit score?
Deferred interest, like any other loan or repayment plan, affects your credit score the same way a typical financed purchase would. As long as you repay your balance in full and on time, your credit score won’t just not be negatively impacted, but you may even increase your score for making your payments each month.
What are the biggest drawbacks of deferred interest?
With deferred interest, you are afforded the opportunity to benefit from a zero percent interest loan. But this only applies if you repay the amount you borrowed by the end of the deferred interest period. If you fail to repay your entire loan amount, you are liable for the interest accrued on the total amount and not just what you have left to pay. Some factors to be aware of when considering taking out a deferred interest loan include:
- The amount of interest you may potentially have to repay: Before agreeing to a deferred interest loan or credit charge, ask yourself, “would I be able to repay the interest on this purchase if I don’t make all my payments in time?” If the answer is “no” or “I’m not sure,” remember the possibility that you may be responsible for the total amount of interest if you default on the loan or do not pay off your credit in time.
- The interest rate is usually pretty high on the item you’re purchasing: There is a reason why stores often incentivize buyers with deferred interest. It is because there are probably plenty of people who do not repay their balance by the end of the deferred interest period who are then charged with the interest on the whole purchase amount. Stores make their money back on deferred interest financing whenever someone defaults and has to pay the 20-40% interest rate on the item they purchased, perhaps even years ago.
- Life is unpredictable: To state the obvious, you never know what may happen tomorrow, and taking on a deferred interest loan means you are obligated to make payments every month for the entire duration of the deferred interest period unless you pay off your balance early (which is always a good idea). When catastrophe strikes, it may not be as easy to come up with your entire payment amount each month if at all, depending on the circumstances.
Is it a good idea to take on deferred interest?
Anytime you take out a loan, it is important to understand the implications of your decision to borrow money. While it is not necessarily a good idea to take on any type of additional interest with the potential to accumulate over time, deferred interest gives you the opportunity to evade interest payments provided that you repay the amount borrowed before it’s too late. Deferred interest can be extremely beneficial, and as long as you are aware of the conditions of your deferred interest agreement, you would be wise to make the most out of this powerful financing tool.