What Is Deferred Interest?
Let me explain deferred interest to you directly: it's when interest payments on a loan get postponed for a specific time frame. You won't pay any interest during this period as long as you clear the entire loan balance before it ends. But if you don't pay it off in time, interest starts piling up, and it can hit hard.
Deferred Interest on Mortgages
You might also see deferred interest in mortgages, often called deferred interest mortgages or graduated-payment mortgages. These work a bit differently, and I'll get into that shortly.
Key Takeaways
- A deferred interest loan postpones interest payments till after a certain period of time.
- If the loan is not paid off by the specified time, interest starts accruing.
- The interest paid can sometimes be backdated to the entire loan balance and include high-interest rates.
- Deferred interest loans are typically found on credit cards or offered by retailers.
- Mortgages can also include deferred interest options, in which the unpaid interest is added to the principal balance of the loan, also known as negative amortization.
- Generally, deferred interest loans are not considered a financially prudent means of financing.
Understanding Deferred Interest
Retailers often provide deferred interest options for big-ticket items like furniture or home appliances, and I want you to understand why: it makes buying these things easier and more appealing than paying upfront or taking a loan with immediate interest that jacks up the cost.
These options usually run for a set period with no interest charged. But once that time is up, if you haven't paid the balance, interest kicks in—sometimes at steep rates. You need to pay close attention to the deferred interest period and all the fine print in the terms. Make sure you can pay off the loan before the no-interest window closes. Retailers push these through their own credit cards or in-house financing.
Credit cards can offer deferred interest too, often as a hook to get you to sign up. These cards function like retailer loans: no interest on the balance for a promo period, then charges start on what's left or new balances. If you're thinking of switching to one for a balance transfer, check that it's among the best options out there.
Here's a key point: with most deferred interest loans, if you don't pay the full balance before the period ends, interest gets backdated to the original full amount, no matter how little is left unpaid.
Mortgages with deferred interest are different. Any unpaid interest from your monthly payment gets tacked onto the principal, which is negative amortization. For instance, payment option ARMs or fixed-rate mortgages with deferrable interest can see payments spike later, raising the risk.
Deferred Interest on Mortgages in Detail
Before the 2008 mortgage crisis, loans like payment option ARMs started with low payments for the first few years, then jumped way up. You could pick from options like a 30-year or 15-year amortizing payment, interest-only that doesn't touch the principal, or a minimum payment that doesn't even cover interest. That shortfall—deferred interest—gets added to the loan balance as negative amortization.
Take this example: suppose you have a $100,000 payment option ARM at 6% interest. Your monthly choices might be a 30-year fixed payment of $599.55, a 15-year one of $843.86, interest-only at $500, or minimum at $321.64.
If you go with the minimum, $178.36 in deferred interest adds to the balance each month. After five years, the loan recasts, and payments rise to pay it off in 25 years. That can make payments unaffordable, leading to foreclosure. This is why some states ban these loans, and the feds see them as predatory. Overall, deferred interest mortgages hike up your total costs and are a risky choice.
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