While Americans are notorious for carrying credit card debt, we're even more likely to rack up hefty bills during the holidays. From gift-giving to the lure of Black Friday, many of us are fairly quick to whip out our credit cards -- even if our finances aren't so great.
According to a 2015 Harris Poll, 65% of Americans say they typically use credit cards to pay for at least some of their holiday purchases. And while there are certain benefits to paying by card instead of cash, there are a number of drawbacks, too. In fact, there's one lesser-known credit card trap that can really wreak havoc on your finances this season, so much so that you might still be reeling from it come this time next year. It's called the deferred interest trap, and you'll want to avoid it like the Wal-Mart parking lot on Black Friday.
An offer too good to be true
As the term implies, deferred interest is a fairly simple concept: You can buy now and pay no interest for a number of months, but if you don't repay your loan in full by the time your grace period ends, you'll be subject to interest charges -- charges that are likely to be higher than average. Deferred interest programs are a popular choice for shoppers who want to buy expensive items and don't have the money to pay up front but expect to have the cash in a few months' time.
Say you're looking at a new appliance that costs $1,000, you don't have the money right now, but you're expecting a work bonus in a couple of months that will cover your purchase. You have two choices: You can pay for that appliance with a credit card that charges 14% interest, or you can choose a deferred interest plan with a three-month grace period and 24% interest thereafter. If you're convinced you'll have the money soon enough, it may seem like a no-brainer. But what happens if that bonus doesn't come through, or you wind up needing it to cover an unplanned expense? Suddenly you've fallen into the deferred interest trap, and your finances are bound to take a beating in the process.
See, what most deferred interest programs don't tell you is that if you fail to repay your debt within your grace period, your lender has the right to retroactively apply finance charges to your original purchase amount in full. In other words, say you bought that $1,000 appliance and paid off all but $50 of it by the time your deferred interest period ran out. You won't just owe interest on the remaining $50; you'll be liable for interest on the entire $1,000 and from the original purchase date.
Now if you're thinking you'll just make sure to repay what you owe in time and essentially score a free loan, not so fast. It's a good idea in theory, but it may not work out that way. According to a new survey from T. Rowe Price, 16% of holiday shoppers will take more than six months to repay their seasonal credit card debt. If you sign up for deferred interest financing, you may wind up with more debt than you bargained for.
Transparency is key
In an ideal world, retailers, along with the banks and major credit card networks that back their store cards, would be open about the terms of their financing agreements, allowing consumers to make smart, informed decisions. In reality, businesses stand to make money by suckering poor, unsuspecting shoppers into signing up for deferred interest financing, and if you're not careful, you could end up being one of them.
Thankfully, WalletHub just released a study that ranks retailers' transparency in their financing agreements, and it found that some companies are more forthright than others when it comes to explaining how their deferred interest programs work. The biggest offenders include Pottery Barn and West Elm, both subsidiaries of Williams-Sonoma (NYSE:WSM), while the most transparent retailers include Apple (NASDAQ:AAPL) and J.C. Penney (NYSE:JCP).
Regardless of where your favorite retailers fall on the list, be sure to read the fine print before signing up for a financing agreement. No matter how straightforward that contract might seem, remember that the ultimate goal is to get your money one way or another. Consider yourself warned.
Maurie Backman owns shares of Apple and Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Williams-Sonoma. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.