What is Deferred Interest?
Deferred interest is a deal offered on what is essentially a loan, allowing the borrower to avoid paying interest for a set period of time, provided the borrower has paid the entirety of the loan or the cost of a specific item. Such a type of deal is popular when it comes to expensive commodities – cars, furniture, and home appliances.
All the items listed above typically carry a hefty price tag. A deferred interest deal is a way for the commodities’ suppliers to lure customers into believing they are receiving a better deal because interest expenses are withheld for a certain amount of time. If, however, the borrower or buyer doesn’t pay the entire balance of the loan within the promotional, “interest-free” period, interest costs start to accrue.
In some cases, the borrower/buyer may be required, then, to pay all the interest that would’ve accrued during the promotional period, regardless of how much of the principal balance of the loan has been paid off.
- Deferred interest is a deal that allows a borrower/consumer to avoid interest payments for a period of time, provided the balance is paid off during the interest-free period.
- Deferred interest is slightly different when it comes to mortgages; if the monthly balance during the interest-free period isn’t paid in full, interest on the balance is added to the loan’s principal balance. Such types of loans are often considered predatory and are banned in several states.
- There are several issues concerning deferred interest, including retroactive interest charges, hidden fees, and excessively high interest rates.
Deferred Interest on Credit Cards
Deferred interest deals are popular on credit cards as well. Yet again, it is a tactical maneuver to entice consumers to sign up for a credit card company’s card. The card will often promote a “no interest” deal when, in reality, it is simply holding interest for a set period of time. If the individual continually pays off the credit he or she used during the period, there is no interest. It is the same type of deal offered by retailers or lenders.
Once the no-interest period ends, the consumer begins to pay interest on whatever balance remains and balances that accrue as the consumer continues to use the card.
It’s advisable to carefully look over the terms surrounding a deferred interest (“no interest”) card before signing up for one. Companies offering such cards may sneak in additional fees for late balance payments or add back-interest if the full balance remains unpaid during the deferred interest period.
Deferred Interest on Mortgages
The deferred interest deal works with a slight difference when it comes to mortgages. If the borrower is unable to settle the full monthly balance on the loan throughout the deferred interest period, the unpaid interest is added onto the loan’s principal balance.
The process of adding deferred interest amounts to the principal balance of the loan is called negative amortization.
Adjustable-rate mortgages (commonly referred to as ARMs) are more likely to come with the deferred interest feature. Monthly payment amounts on these loans may increase at a significant rate throughout the loan if the borrower doesn’t continually pay off the monthly balance during the period where interest is deferred.
Mortgages with deferred interest are widely considered predatory by the federal government and are even banned in some states. It is because most borrowers of such types of loans are lower-income and tend to make minimum monthly payments. It means the deferred interest on each month gets added to the loan’s balance.
After some time – usually within five years – the loan is recast with a significantly higher balance than when the loan was first issued. In many cases, the borrower becomes financially incapable of paying off the loan and defaults, sending the home into foreclosure and leaving the borrower without a place to live.
The Biggest Issues with Deferred Interest Deals
1. Retroactive charges
Retroactive charges are something we’ve already discussed in this article. It all depends on the company, the provider, and the terms of the deal. In some cases, if the principal balance of a loan or the amount owed on an item isn’t paid off during the deferred interest period, retroactive interest payments may be added to the amount the consumer owes, meaning he or she must pay full interest charges for the deferred interest period.
2. Hidden charges, fees, and rules
Many lenders include hidden charges, fees, and rules to begin retroactive charges in the fine print of deals. Consumers often don’t understand the language of such caveats, which are tactically tucked into paperwork that consumers aren’t reading carefully.
3. High interest rates
In most cases, when it comes to deferred interest deals, the interest rate is high, often somewhere in the neighborhood of 20% or more. Even if an individual pays off what is owed during the promotional period, the interest going forward is going to be steep. If retroactive interest is applied, the debt could cripple or bankrupt the borrower.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: