By Carlo J. Silvesti, CPA
Managing your finances and credit rating is always a smart plan, and 0 percent introductory interest credit cards and deferred interest offers can be effective aids in this plan. However, you must be careful of the potential dangers when using these credit tools.
Zero Percent Introductory Rates
Zero percent credit cards are generally used for transfers of credit card balances or loans with higher interest rates. The low rate is offered for a short period of time, and as with all credit cards and loans you must be aware of the terms and conditions that come with the offer. Here are some important points to consider:
- Balance transfer fees – Often there is a fee for transferring a credit card or loan balance to the 0 percent card. These fees can range from 3 percent to 5 percent. So, if you transfer $10,000 to a 0 percent credit card that charges a 3 percent fee, the card company will charge you $300 to execute the transfer. Remember, you must have sufficient credit availability in the transfer card to be able to pay the fee.
- Introductory rate period – The introductory rate period will vary from card to card. Under federal regulations it must be at least six months. Often, introductory rate periods will be between nine and 18 months.
- Introductory interest rate – Although you are offered a 0 percent interest rate, you will need to qualify with a good credit rating. If you do not have a good credit rating, you may be offered a rate ranging from 1.9 percent to 10.99 percent. Be aware of what rate you really are being offered, as this will significantly impact the amount of money you will owe over time.
Once approved for this low introductory rate, you will need to transfer the amounts on one or more existing credit cards to this new card usually within 60 days of receiving approval. You will need to plan to pay off the full amount of the transferred balances within the low interest introductory period. Any remaining balance after the introductory rate period will be charged the credit card’s stated interest rate, which will be significantly higher.
Potential Dangers in Using a 0 Percent Transfer Card:
- Transferring debt is not the same as paying off debt – The transfer of debt is not a repayment of debt. You will need to adjust your spending habits so you can pay off the transferred balance within the low introductory period. Otherwise you will create a more serious financial and credit issue.
- Making purchases on the low-interest-rate card – Be careful when using the balance transfer card to make other purchases. Any monthly payments you make will be applied as follows: the minimum monthly payment will be applied to the low introductory amount and any excess amount will be applied to your purchases, unless you notify the credit card company of how you want your payments allocated. I recommend not using this card to make additional purchases until you complete paying off the transfer amount.
- Timely repayment is critical – You must make timely payments. If you make a late payment, have a payment returned for insufficient funds, or exceed your credit limit on the card, you can lose the low introductory rate. If you make two late payments, you will pay a penalty rate on the card for the following six months of on-time payments. These penalty rates are significantly higher than the standard interest rate most cards charge for new purchases.
Deferred Interest Borrowing
A deferred interest borrowing program is often used to make large purchases, such as for expensive electronics or furniture. The borrowing needs to be paid off during the period of the deferral. If the borrowing is paid off during the specified period, then all of the potential interest is forgiven. If you do not pay off the borrowing in the time period provided, all of the deferred interest will come due, and you will be required to pay all that interest. When entering into a deferred interest borrowing program, carefully review all the terms and conditions.
Deferred Borrowing Example: You purchase $5,000 of furniture with credit terms of 24 months to pay it off. If you do not pay it off during the time period, you will be charged 23 percent interest on the full amount from day one.
- Scenario 1 – You pay $209 each month for 23 months and a last payment of $193. You will owe $0 interest.
- Scenario 2 – You pay $209 each month for 23 months, but forget to make the last payment of $193. You will owe $2,300 in interest. The interest is calculated as follows: You only made $4,807 of payments ($209 x 23 months) and are short $193. Under the terms of the agreement, you owe 23 percent interest on the full amount of the purchase from day 1. This results in $2,300 in interest owed. This is calculated as $5,000 x 23 percent interest rate x 2 years = $2,300.
Depending on the terms of the agreement, you may be required to make equal monthly payments to retire the debt during the deferral period. Know that there may be “minimum payment” requirements that do not retire the entire debt during the deferral period. Since the 2008 financial crisis, lenders must state the interest rate assessed from the purchase date. Some companies show the amount of interest deferred each month, that way you are aware of how much interest you are accruing and may owe if you do not pay off the full debt in time. In most lending programs, interest rates that are being deferred are usually 20 percent to 25 percent.
Potential Dangers in Using Deferred Interest:
- Failure to make timely payments – This can result in you losing the remaining time on the deferred interest, and all interest owed will be added to the purchase.
- Failure to pay off the entire balance in the deferral period – If any balance is still owed at the end of the deferral period, the entire deferred interest will now be owed. Even if the amount owed is only $50 on a $5,000 purchase. This can be a significant amount of money.
Zero percent balance transfers and deferred interest borrowing can be effective tools when you make purchases. Just know that they are not without risks. Make sure you plan accordingly to meet the terms and conditions so that you don’t wind up paying more in the end.
Carlo J. Silvesti, CPA, is an associate professor of accounting at the Gwynedd Mercy University School of Business and Education. Prior to joining Gwynedd Mercy University, Silvesti served as a CFO and controller for 35 years at several small and midsize businesses. He can be reached at email@example.com.