-What is a promotional period for a deferred interest credit card? -What is deferred interest and why would I would need to pay it?
-What is the interest rate on the credit card when the promotional period ends? -What is the benefit to the budget plan when using a deferred interest credit card?
Okay now it’s time for this week’s financial topic and this will be our question of the week.
This comes from Austin who ironically is from Austin, Texas. His question is . . . do you recommend using short-term debt vehicles like PayPal Credit (pay on credit now with no interest if the balance is paid off within a promotional timeline say 12 months, given I do have the money to pay it off upfront?
So what we are talking about is a deferred interest credit card.
This is a great question and people often take this route when they do not have enough money to buy products outright.
This occurs with larger ticket items or products purchased in sets of related items. Examples of this would be from furniture stores, or appliances or electronics from the Best Buy’s of the world or purchases for just about anything that you can finance through vendors such as PayPal.
So when looking at this, financial experts have differing opinions and this depends on why you are doing it. So let’s explore the scenarios:
First and foremost you shouldn’t buy anything that you can’t afford. This is the premise that we base everything from.
However, let’s at this from more of the realism aspect in that 75% of all people live paycheck to paycheck.
Secondly 50% of all Americans do not have $400 for an emergency expense.
So what we are saying is that as much as we’d like for people to have the money before making a large purchase, we need to look at is the reality of what people are going to do.
Making a Large Purchase with Zero Percent Interest
So let’s take a scenario and say that you are going to buy a new furniture set for $2,000 with an option to pay for this over 24 months at 0% interest.
So the first rule is that as long as you pay off the credit card with regular installments before the 24 months expire you will accumulate no interest payments.
The second rule is that the installments have to be made with at least the minimum payment.
The third piece to this is that while you were making these payments, the interest is accrued and held in a pseudo tank; however, you will not be charged this money as long as you make the payments within the 24 months.
For example, let's say you are just $1 short of paying off the full balance before the 24th month is completed, this means that you will owe all of the accumulated interest that has piled up.
The other piece is that interest rates on these cards are very high. The average credit card interest rate in the United States is around 16% and the average interest rate for deferred interest credit cards is in the mid 20’s.
Okay let’s run through an example:
How the Deferred Interest Credit Card Works
You opt for a card that offers “no interest if paid in full in 12 months” when you use your account to buy new furniture.
You charge $2,000 worth of appliances on your account. You decide at first to pay $250 per month on the card to reach a zero balance by the end of month 12.
Then at month number eight, you start making the minimum monthly payments which are typically in the 3% range. Further to that, at the end of the 12-month promotional period you have an unpaid balance of $500.
What Happens if My Balance is Not Paid in Full?
So now what happens is that the credit card issuer retroactively charges you interest (using the regular annual percentage rate or APR) on the full $2,000 original purchase.
So this leads back to what we said earlier; that the interest is tallied from your original purchase date to the end of the promotional period.
Therefore, the interest that you didn’t pay off will show up on your credit card on top of the unpaid principal balance and then from that point forward, you have to continue paying interest at that 25% rate until you hit a zero balance.
Soooooo, this is not a good route!
Let's Do the Recap
Do we support deferred interest credit cards? Inherently the answer is “no” because you should buy things that you can afford; however, the reality is that most people do not have the money to buy products in cash.
So with that being said these cards are a great alternative to buy products without paying interest providing that they are paid off before the promotional period.
Be certain that you can meet the commitment, otherwise you’ve just simply added another credit card that has an usually high interest rate that can put you in a worse position than you intended.
A good option to consider is to buy used furniture or any product for that matter at estate sales or avenues such as Facebook Marketplace. You can find great products this way for much lower cost.
How important are the products or services that you’re considering meaning, before you make a purchase, do you really need to make that purchase?
That is often the biggest budget mistake people make right? Even even with us. You’ll say that I want to replace this thing . . .
I want to replace everything.
I’ll say that we’ve had this item for a year-and-a-half . . . Does it satisfy the need? Is there a functional need to buy this item and the answer usually, no. It’s different if you can afford to buy the things want and that's your business, but with that being said, if your dining room table isn't falling apart can you repair it?
What if your refrigerator breaks down and you absolutely need a new one and you are short on funds? Obviously that's a good opportunity to make those minimum payments as long as you pay it off within that promotional timeline.
So this gets back to what we always talk about which is the budget. So try to budget effectively so that you can keep yourself out of these positions. So if you have part of a rainy day fund or have $1,000 for that $3,000 refrigerator, at least some of the money was saved to reduce the balance.
Try not to put yourself in a spot where everything that you're buying, even if you don't have a lot of money, is always on credit.
I like these promotional cards. We’ve used them for example to buy appliances in the same regard years ago because we needed liquidity; it was a good way to keep money in the bank.
If you don’t have the ability to pay things with cash, but you're in a position where you do need liquidity, just make sure that you can handle the commitment. Don't reach the end of the promotional period and then end up paying interest. This is the worst mistake that you can make.
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