Consumers don't like being fooled. Regulators don't like it either. That's why bankers should stop offering deferred-interest financing.
As you may know, deferred interest is a feature that allows a lender to offer the consumer a line of credit with a low introductory interest rate while reserving the right to retroactively assess finance charges at a much higher rate usually 25% or above to the entire original purchase amount if and when the borrower misses a payment or fails to pay off their entire balance within the allotted introductory term.
That, according to a recent CardHub study, means an unsuspecting consumer who is lured by the sticker appeal of a deal offering 0% for 12 months could see their debt suddenly become over 27-times more expensive than they'd planned, simply as a result of paying a day late.
Out of the 70% of major retailers that currently offer financing, 49% use deferred interest. That includes the likes of Apple, Amazon, Best Buy, Macy's and Lowe's. Forty-one percent of those retailers aren't transparent about the deferred nature of their financing plans either. And while a number of major financial institutions are involved in the deferred-interest game, two in particular dominate this unfortunate niche: Citi (32% market share) and General Electric (32%).
In short, these retailers and the banks through which they offer deferred-interest lines of credit are playing a very dangerous game. They are using an unsustainable, underhanded tactic to boost short-term revenues and attract new customers. Moreover, they are doing this in an extremely competitive post-recession environment, where financial institutions are tripping over one another to acquire consumers who have excellent credit in order to insulate themselves against future economic turbulence.
The question is: can they retain these soon-to-be-disgruntled customers with the aid of attractive cross-sales or simple inertia? Will there be consistent revenue growth or a forthcoming cliff?
These types of schemes rarely pay off in the end, and they certainly never represent an efficient use of funding. Consumers are also switching banks more often than ever these days and have a wealth of new product comparison tools at their disposal. Banks would therefore be well-advised to make some immediate price-structure changes. Based on the best practices I've witnessed during my 13-year career in the credit card space, I would recommend the following:
Abolish unfair practices. Based on the premise that bait-and-switch is a bad long-term strategy, it would be wise to not only curtail use of deferred interest, but also to re-evaluate your overall strategy in order to identify other potentially problematic practices.
Strive for industry-leading financing and rewards. Whether you chalk it up to improved financial literacy or circumstantial necessity, consumers are becoming increasingly adept at parsing the fine print of financial products and identifying deals from the isles of the supermarket to when shopping for a credit card online. That is why the most successful credit card issuers base their products on what is most important to their target audience: typically, lucrative rewards bonuses, long 0% financing offers (without deferred interest) and high ongoing rewards earning rates.
Integrate underwriting: In order to afford the abolition of unfair practices as well as the implementation of a market-leading price structure, you'll need to reduce losses. Integrating your underwriting team which should be the backbone of any lending operation into all aspects of product development and marketing is the best way to do so, as it will ultimately force your organization to make smarter decisions.
Transparent terms always win out when all is said and done, as they force both consumers and regulators to behave in a predictable manner. Bank executives would do well to keep that in mind as they consider the surprises that await people who use deferred-interest financing this holiday season.
Odysseas Papadimitriou is CEO of the personal finance social network WalletHub and the credit card comparison website CardHub. He previously served as a senior director in Capital One's credit card division.