Deferred interest promotions should be more transparent, the Consumer Financial Protection Bureau told retail credit card companies in letters encouraging recipients to be more open with consumers.

What happened

Many retailers use credit cards with deferred interest promotions, where consumers are charged no interest for a set period if the promotional balance is paid in full by the end of the period. But in letters sent to “top retail credit card companies,” the CFPB outlined its concerns about the products, cautioning that consumers may be surprised by the “high, retroactive interest charges” that begin after the promotional period ends.

“With its back-end pricing, deferred interest can make the potential costs to consumers more confusing and less transparent,” bureau Director Richard Cordray said in a statement. “We encourage companies to consider more straightforward credit promotions that are less risky for consumers.”

In 2015, the CFPB studied deferred interest products. While the bureau found that the promotions offer substantial benefits to some consumers, they pose “significant costs and risks” to others. “In particular, our review raised concerns that deferred interest products may lack transparency to consumers, as a consequence of the back-end pricing that can be a feature of these products,” the CFPB wrote in its letters.

Because the costs are not incurred until the end of the promotional period, the costs of such offers are typically less transparent, the bureau said. Adding to the problem: consumers are unaware that interest actually starts accruing from the date of purchase and will be added back on top of the remaining principal balance if the promotional balance is not paid in full by the deadline at the end of the promotional period.

These charges can be “substantial,” the CFPB added, as the nonpromotional interest rate on such offers is generally around 25 percent. “Those who fail to pay off the balance in full, for example those with even a very small balance carried past the promotional expiration date, can end up owing much more in interest than the remaining balance due,” the bureau wrote. “We have received many consumer complaints from people who have found that they have incurred this unexpected charge.”

A large portion of the consumers who fail to repay their entire promotional balance before the deadline do manage to pay off the entire balance and associated interest charges shortly thereafter, leading the CFPB to speculate “that many consumers do not fully understand how deferred-interest promotions operate and the manner in which interest is assessed on these products,” a problem complicated when the account is used for other purchases as well.

“Successful implementation of deferred-interest programs requires robust compliance management systems and third-party oversight measures that ensure consumers are fully informed of the terms and true costs of promotional financing,” according to the letters.

The CFPB suggested an alternative: 0 percent interest promotions, where consumers are not assessed interest retroactively if the promotional balance is not paid in full by the end of the promotional period.

“As long as the end date of the promotional period is clearly disclosed, this approach is easier for consumers to understand,” the CFPB said. “And its costs may be more straightforward. If consumers do not fully repay by the promotional end date, they have the opportunity to resolve their debts without incurring an unexpectedly large lump-sum financial cost.”

While this change only benefits the consumers who fail to pay their promotional balances in full by the deadline at the end of the promotional period, “it is precisely these consumers who are likely to be most at risk,” the bureau noted, such as consumers who suffer an adverse economic shock like an unexpected medical bill or job loss. “This change in promotional terms may assist consumers who do not understand the full costs of failing to pay the deferred-interest promotional balances and make it easier for them to repay their debts following financial hardship.”

To read a sample letter from the CFPB, click here.

Why it matters

Why send the letters now? Last month a “major U.S. retailer, in partnership with one of the largest U.S. credit card issuers” decided to stop using deferred-interest promotions on its credit card program, the bureau said, switching to the 0 percent interest promotion option. “We commend this decision and want to bring it to your attention,” the letters stated. The CFPB’s letters also put retailers and card issuers on notice that the bureau is keeping an eye on deferred-interest promotions.