How to avoid store credit cards with a potential debt bomb

By Chris Taylor

NEW YORK (Reuters) – As you gear up for last-minute holiday shopping at any big box retailer, there is a good chance you will be offered a store credit card with a nice discount on today’s purchase and even a 0% interest rate for an introductory period.

What’s not to like, right?

Alas, some store credit offers are tripwired with something called ‘deferred interest,’ which can be a nasty little debt bomb.

So how does it work? 

“If you don’t pay off the balance in full by the end of the promotional period, you’ll owe interest on the entire purchase amount from the original date,” explains Melissa Caro, a New York City financial planner and founder of the platform My Retirement Network.

That means you could end up paying 27.5 times more compared to general-purpose credit cards, which do not use deferred interest, according to a new study by financial information site WalletHub.

The site reviewed store cards offering 0% introductory rates and found 85% of them are using deferred interest.

“Deferred interest is the most misleading thing that currently exists in the credit-card market,” says Odysseas Papadimitriou, WalletHub’s founder and CEO.

Of course, consumers rarely read the fine print of those credit-card agreements, and the person at the checkout counter likely is not going to know about financing details, either. 

In fact, 61% of people do not even know how deferred interest works, according to the WalletHub survey.

The other problem here: Interest rates on store cards are typically extremely high. The current average is over 33%.

So how can consumers protect themselves from a high-interest surprise? Here are five factors to consider. 

NOT ALL STORE CARDS ARE ALIKE

Some store cards will not whack you with deferred interest. Among those, according to the WalletHub survey: The Gap, Williams Sonoma, Neiman Marcus, Nordstrom (NYSE:JWN), Costco (NASDAQ:COST), Target (NYSE:TGT) and Pottery Barn.

Others may not right now but reserve the right to do so in the future. So ask about deferred interest before you sign on the dotted line.

Here is one potential clue: 95% of all deferred interest credit cards are issued by just three banks – Synchrony, Citi, and Comerica (NYSE:CMA), WalletHub says.

OPT FOR NON-STORE CREDIT CARDS 

If it is the 0% introductory offer that is appealing to you, fine – just get it from somewhere else, like your own bank, instead of a retailer-branded one.

“The simplest advice we have is, give preference to a regular general-purpose credit card with a 0% offer on it,” said Papadimitriou.

Not only will it not come with deferred interest, but the eventual interest rate will likely be lower as well. Average interest rates for general-purpose credit cards are currently 20.37%, according to the latest data from financial information site Bankrate.

BE REALISTIC ABOUT WHAT YOU CAN AFFORD

As of November, nearly half of Americans were still paying off holiday debt from last year, according to WalletHub.

So if you realistically do not see yourself paying off a purchase before the introductory period expires – then do the hard thing, and do not buy the item in the first place.

USE STORE CARDS FOR REWARDS, NOT FOR FINANCING

Not all store cards are bad, and there may be good reasons to use them. For instance, maybe the retailer has an excellent rewards program, or offers significant discounts on merchandise whenever you pull it out.

Or maybe you are using a store card to build your credit record, which might be incomplete or spotty. Fine – but then try to pay off balances right away.

“Store cards are great credit-building tools and rewards tools, but horrible financing tools,” says Papadimitriou.

AUTOMATE YOUR PAYMENTS

If you leave credit card payments up to Future You … well, Future You may not have enough cash. And if that happens on a deferred-interest card, watch out.

“The introductory rate can benefit the card user if they are alert,” advises Erika Safran (EPA:SAF), founder of Safran Wealth Advisors in New York City.

What is the best way to handle the typical offer of a 12-month, no-interest new card? 

“Divide the expense by 12, and schedule automatic monthly payments from your bank account to credit card,” Safran says. “You now have a zero-interest 12-month loan.”