What is deferred interest and how does it work?

Deferred interest refers to a financial arrangement where interest charges on a loan or credit card are temporarily postponed, or deferred.

For example, a shop might offer a “buy now, pay later” promotion with deferred interest. During the promotional period, typically ranging from six months to a year, no interest is charged on the purchases made. However, if the balance is not paid in full by the end of the promotional period or if any payment is missed, the accumulated interest for the entire deferred period will be applied retroactively.

“These offers are traps for the unwary,” said Chi Chi Wu, a staff attorney at the National Consumer Law Center. The terms are “confusing to the point of, we think, being a trap.”

It’s important to understand that deferred interest is not the same as waived interest. While deferred interest delays the interest charges, it doesn’t eliminate them. If the terms and conditions are not met or the balance is not paid off within the specified period, the interest will be added to the outstanding balance, and interest charges will apply retroactively.

Here’s how it can work

The lender sets a specific period, usually several months to a year, during which no interest or a lower interest rate is applied to the balance. This period is often advertised as a “special offer” or “introductory period”, though it is important to read the small print to make sure that the debt is actually deferred.

The borrower must meet certain criteria specified by the lender. This may include making minimum monthly payments, paying the balance in full by the end of the promotional period, or other conditions outlined in the agreement.

While no interest or lower interest is charged during the promotional period, interest continues to accrue on the balance. However, it is not added to the outstanding balance immediately.

If the borrower fails to fulfill the qualifying criteria within the promotional period, the deferred interest comes into play. At the end of the promotional period or if any conditions are not met, the accrued interest is added to the remaining balance retroactively.

Once the promotional period ends or if the conditions are not met, the interest rate on the remaining balance typically reverts to the regular, higher rate. This can significantly increase the cost of the loan or credit card balance.

The danger of deferred interest

Deferred interest is likely to be financially risky if not managed carefully. If the balance is not paid off in full by the end of the promotional period or if any qualifying criteria are not met, the borrower will face substantial interest charges, calculated from the original purchase date.