Credit card companies advertise zero percent financing and balance transfer deals all the time. These deals are great for people who are looking to pay down their debt, movers, holiday shoppers, or anyone who is expecting to make a major purchase.
The question remains, how do credit card companies make money on these deals? The secret is in the fine print. Most of these deals are actually “deferred interest” deals. During the entire promotional period, the credit card company calculates the interest that you would owe. If you pay off the entire balance during the promotional period, then you’re in the clear; but if you leave a balance on the card, even as small as a few cents, all the interest that was deferred gets tacked on to your balance, leaving you with hundreds of dollars of unexpected debt.
For example, if you make a $2,000 purchase on a 0% financing card that has a standard interest rate of 20% and you make the minimum $40 payments over the 12-month promotional period, your balance will end up at $1,520. However, once the promotion ends and the back interest is added to your balance, you will owe roughly $1,924.41, leaving you to deal with a balance $400 larger than expected.
A surprise $400 bill is bad enough, but that’s just the beginning. Because credit card interest compounds you’ll begin owing interest on the $400 in surprise interest immediately. If you decide to double your monthly payment to $80 to try to catch up with the new interest you will still wind up paying significant amounts of interest. You’ll pay a total of $555 in additional interest and won’t have the debt paid in full for 31 months, almost three years later. In total, your zero percent interest deal on a $2,000 purchase will have cost you $955 extra in interest. Not such a deal after all.
Are Deferred Interest Cards Good for Consumers?
But most consumers look at the front-end not the back-end of deals, that is, they consider what they want to pay initially not what they will end up paying after all the interest is collected and compounded. In fact, it is so common a practice that consumer associations have taken note of zero-percent deals and their dangers. They are, in short, a “trap for the unwary,” says Chi Chi Wu, an attorney with the National Consumer Law Center. The terms, she says, are so “confusing” as tor represent a trap. Moreover, the deals, often heavily advertised, “prey on the tendency in human beings to be optimistic about these things,” she says, “but life happens.”
Congress has also taken notice of the damage that these deals can cause to consumers. In fact, the Credit Card Act, enacted in the wake of the 1008-2009 financial crisis, specifically call out deferred interest deals. Card issuers are required to disclose the exact terms of how interest will be assessd and automatically apply payments to the highest interest rate balance. Previously, card issuers could apply payments however they want, and often used this to charge consumers as much as possible.
Despite these changes, many think that these deals need to be abolished entirely. Nick Clements, a 15-year-veteran analyst of the credit industry, points out “deferred interest represents one of the worst practices of the credit card industry today … While savvy consumers are able to obtain an incredible deal, people who lack the knowledge are tricked into a complicated product that isn’t as ‘free’ as it seems … Any time you find a product or practice that makes all of its money from a very small percentage of ill-informed customers, you know you have a problem.”
Credit card issuers profit from people who use their cards and want to keep every option open for enticing new customers. When defending the practice of deferred interest, they cite the savvy consumers that Clements talks about. “Deferred interest programs are a popular choice for consumers who need to purchase expensive items,” says Nessa Fredis, a member of the American Bankers Association, “but don’t have the money or savings … The [bank issuers] allow them to make the purchase when they need to and spread the payments over time without having to pay any [initial] interest.”
As she says, it is possible to make use of these deals. Unlike some store cards that offer few consumer advantages, the Amazon store card offers a zero percent interest promotion on purchases that exceed certain amounts. I made great use of this card when I moved into my new apartment, purchasing all the furniture I needed. I felt secure in the knowledge that I could pay the whole bill over the next couple of months without getting hit by interest.
If you want to be one of the savvy consumers who can use a deferred interest deal to get a free loan and save some money then check out these tips. You’ll be using the deals like a pro and won’t have to worry about a painful aftermath.
The easiest and safest way to make sure you pay the full balance before getting hit with interest charges is to use the automatic payment feature of the card. Most major credit card companies allow you to set up an automatic payment from a checking account of your choice. You can set the monthly payment to be the full statement balance, the minimum payment, or some other fixed amount of your choice.
Capital One has a great guide that outlines how automatic payments work if you want to learn more.
Let’s say that you have a card with a twelve month zero percent period. You make a purchase of $1,478.72 in the first month. The easiest way to stretch your payments out and avoid interest is to set up 11 equal payments that will completely cover the full balance. This will leave you with a $0 balance one month before the promotion period ends. This provides a safety cushion in in case you need to reduce a payment one month or an unforeseen situation comes up. A quick calculation shows that $1,478.72 divided by eleven equal payments is $134.429. Round up to ensure that your payments cover the full balance, and set your monthly automatic payment to $134.43.
This method is best if you only plan to make one big purchase/transfer and don’t use the card for anything after that. If you make further purchases, you’ll need to update your automatic payment amounts to account for the increased balance and the reduced time to the end of the promotion period.
This is my preferred method because of its set it and forget it nature. You should create a reminder for yourself a month before the end of the promotional period to check the balance and make sure it is at zero, but in the interim you won’t even have to think about it.
People who use handy apps like Mint.com are likely familiar with the uses of budgeting tools. Mint’s goal feature is great for tracking how long it will take to pay off a card. Add your new card to Mint and it will automatically pick up the total balance owed. Go to the goals tab and select the “pay off credit card debt” goal. Enter the interest rate (0%) and minimum payment, and Mint will tell you when you’ll have the card paid off. You can then adjust the slider to increase your monthly payment and watch as your payoff date changes. Move the slider until the payoff date is one month before the end of the promotion. That’s the amount you need to pay each month.
Every month, Mint will remind you about your goal, prompting you to go to the credit card’s website and make a payment. This strategy is ideal for people who plan to make more purchases on the card because you can recalculate the necessary payment.
Zero Percent Interest and Balance Transfer Deals
With so many companies offering zero percent promotions it can be hard to choose the right card. Here is a list of some of the best deals.
Citi® Double Cash Card
This card provides a double whammy of benefits, featuring the best cash back of any card on the market, as well as 0% APR on purchases and balance transfers for 18 months. This is the ideal card for someone who has good credit and wants to earn rewards on a big purchase but needs flexibility when paying it off.
Another Citi card with a great zero percent financing deal. This card’s promotional period is 21 months long giving you plenty of time to pay the balance.
The Amazon.com Store Card
The perfect card for the Amazon shopper. Rather than serving as a sign-up bonus, this card offers zero percent financing on purchases that meet certain dollar amounts. Amazon Prime members also get the option of 5% cash back on purchases.
Zero percent financing deals are powerful tools when used properly, making sure you avoid unexpected charges make them a great way to stretch your money further.
TJ Porter has in-depth experience in reviewing financial products such as savings accounts, credit cards, and brokerages, writing how-tos, and answering financial questions. He has also contributed to publications and companies such as Investment Zen and Echo Fox. He aims to provide actionable advice that can help readers better their financial lives. In his spare time, TJ enjoys thinking up new ways to optimize my own finances, in addition to cooking, reading, playing games (of the board and video variety), soccer, ultimate frisbee, and hockey.