The Hot Holiday Financial Trap to Be Aware of While Shopping Deals
In the “stuff that probably doesn’t surprise you” department comes this breaking news:
Credit card companies and retailers are in it for the money. If they give you an offer that seems great, it’s smart to look at where they stand to profit.
You know this, and keep it in mind throughout the year, but the most recent research says that 65% of Americans use credit for some or all of their holiday gifting purchases. Many of us use our existing credit cards, and pay off the balance during our grace period, leveraging good credit intelligently. Some of us end up spending a little more than we can afford, and pay some interest in January, February and even March before we’ve cleared the balance and gotten back to normal.
Some of us — and an increasing number — take advantage of “zero interest” financing, which is a trap that ends up costing consumers more than just using their existing credit cards. Here’s how it works, and what you can do about it.
Zero Interest Doesn’t Mean Zero Interest
You’ll find out in the small print that it really means “deferred interest.” You really do pay no interest until the end of the zero-interest period (typically three to six months). At the end of that time, if you’ve paid off the entire balance, you’re in good shape. But if not, they’ll add interest on the balance for every month that has passed.
Worse, you’ll find the rules of payment are set up to keep that balance untouched. If you use the credit card or account for any other purchases, your payments will be applied to that balance first and only the leftover amount applied to that zero interest balance.
Worse still, zero interest deals are usually attached to cards or accounts with some of the highest interest rates in the country — the ones based in North Dakota because every other state defines rates that high as a criminal offense akin to loan sharking. Consumers can easily wind up spending way more on interest in one of these deals than if they maintained the balance on a regular credit card.
It Exists to Get You to Extend
Even with the game rigged heavily in their favor, credit cards offering these kinds of deals still stand to lose. So why do they make the offer?
Because it encourages you to spend more than you can afford to. Especially in the holiday season, when you’re buying for loved ones, the temptation to “go big” can push you to buy something out of your price range. It’s a generous impulse, but limits not only your financial health but your long term ability to be generous moving forward by trapping you in the following process:
Step One: You spend more than you should have on a gift, putting it on a zero interest account
Step Two: Your holiday spending stretches you thin in the beginning of the year
Step Three: This keeps you from paying off that balance within the zero interest window
Step Four: The accumulated interest and high interest rate put you in a spot for the rest of theyear
Step Five: You rely on zero interest financing for all your holiday gifting the following December
Over the course of this process — which can become a cycle — you pay more than you would have using your regular credit card (and far more than if you had restrained your holiday spending to what you could buy for cash).
The Solution: Pay Early, Pay Often
The best plan for holiday gift spending is to limit what you buy to what you can pay for out of your bank account, but not everybody is okay with keeping their gifting that low. We’re not here to tell you not to spoil your kids or grandkids absolutely rotten (or to buy your house a new appliance for Christmas) but here’s what we recommend you do if you decide to take advatage of a zero interest purchase option.
Start by understanding the exact terms of the agreement. What is the interest rate on unpaid balances? How is it calculated? When does the period end?
Create a plan for paying off the entire balance before the end of the zero interest period. Time payments to coincide with paychecks, and make the payments first so you’re never tempted to spend on something else.
Consider your plan to make sure it’s realistic. If you can’t realistically afford to make payments on time, you need a new plan. This step isn’t just important because it checks your assumptions against reality. It also forces you to slow down and think, which can remove some of the pressure and excitement about making what’s ultimately an unwise purchase.
Follow your plan to the letter and pay off the balance well before the end of your zero interest period.
Like so many financing offers, zero interest financing should be held up against the Grandma Test. As your grandmother used to say “If it seems too good to be true, it probably is.”
Have you encountered the zero interest financing trap? Did it cost you big? Or did you navigate it to your advantage? Tell the community about it in the comments below and join the conversation.