Understanding Deferred Interest: Calculation & Implications

Banks, credit card companies and other lenders routinely offer accounts or products with deferred interest. With a loan or other debt, deferred interest means that you either do not pay interest for a specific amount of time or you pay less than the minimum balance and pay the difference plus interest later. The terms, meaning and calculation of deferred interest changes with each lender; be sure that you understand the rules of the contract before signing up.

No Interest for Several Months

Step 1

Determine if your deferred interest offer suspends interest for a number of months, which is common with credit cards and installment plans for large consumer items such as furniture.

Step 2

Read the contract and determine if there is no interest at all for the time period stated in the contract or if the interest accumulates and you have to pay it after the time period ends.

Step 3

Find the interest rate in the contract and the amount of time that you have to pay the debt.

Step 4

Multiply the amount you owe by the interest rate and the number of years you have to pay it back. For example, if you bought a $1,000 couch at 10 percent a year and have two years to pay, you will pay $200 in interest: (1,000)(0.1)(2). If the interest accrues, you have to pay $200 — two years of interest — back in one year, plus the $1,000.

Step 5

Subtract the interest from the interest free period if the interest does not accrue. For example, if the $1,000 generates no interest for 12 months but you pay the debt back in 24 months at 10 percent a year, you owe $100 in interest: (1,000)(.1)(2) - (1,000)(.1).

Negative Amortization

Step 1

Determine if your contract allows you to pay less than the monthly minimum but adds the difference to the debt. This type of deferred interest is common in mortgages and is also called negative amortization.

Step 2

Add the amount that you do not pay every month to your principal — the original debt. For example, if you have a 30-year mortgage of $100,000 but pay $500 less than the monthly minimum each month for a year, your principal goes up to $106,000.

Step 3

Multiply the new principal by the interest rate; the product is the amount of interest that you owe. For example, a $106,000 mortgage at 5 percent a year generates $5,300 in interest for the lender

Tip

Read the contract and rules carefully before signing. Be sure to clarify any questions with a representative.