Saturday, November 25, 2006

O% Credit Cards and Signature Loans

A few days ago, a friend came to me and explained a financial scenario that he was considering. He wanted to know if I thought the scenario was a good idea. Now, I'm no expert in all things financial, but I do have opinions and some knowledge in this area.

(I'm also known as a person who can squeeze a penny till Lincoln squeals, but that's another story.)

Anyway, this person, we'll call him Ron, said that he needed money to move, but didn't have any saved. He said that he had a plan to get the money and wanted my opinion of his plan.

Ron had been mailed one of those "0% APR for 6 months" credit card offers and thought that he would take out a signature (or personal) loan from a local finance company to pay for his move, then use the "0% APR for 6 months" credit card to pay off the signature loan.

The local finance company was charging 28% APR for a signature loan, but Ron figured he could pay it off as soon as he got the "0% APR for 6 months" credit card in the mail. His thinking was that he would end up paying no or very little interest on the whole deal.

He wanted to know if this would hurt his credit and if I thought it was a good idea. I didn't think it was a good idea.

Here's why:
  1. My first thought was, "I don't think your credit card application will be approved once they run your credit history and find a new signature loan in your credit report." Signature loans are often considered "high risk loans" because of their high interest rates and high frequency of default (Top 7 Ways to Improve Your Credit Score-Play by the Rules).
  2. Hard credit inquiries hurt (lower) your overall credit score and he was going to add two hard inquiries in less than a month (How Credit Scores are Calculated-Interest in obtaining new credit).
  3. The Credit Card company may not offer a way to pay off the signature loan other than a Cash Advance, which may not be included in the 0% introductory offer. And, a cash advance may incur interest as high as 30% APR.
  4. If Ron makes just one payment late, that 0% APR skyrockets to the Default interest rate, which can be much higher than the normal (non-default) APR.
  5. Using a Credit Card to pay off a Signature Loan is a dangerous juggling act that will fall apart with one mis-step. If Ron takes out a Signature Loan first, then finds that he can't get the"0% APR for 6 months" credit card, he will be paying 28% in interest throughout the life of the loan.
I'm assuming that Ron needs a loan because either his take-home pay is not sufficient to enable him to save money, or he is managing his money very poorly (or both). In either case, I don't think that adding new debt to an already precarious financial situation will improve his money management skills.

So, lowering his credit score by adding two hard inquiries, taking a chance that one of the credit applications may be turned down, risking the possiblity of having to pay a cash advance rate on the credit card, and the risk of making a mistake or making one late payment, means that if one thing goes wrong, Ron will go from struggling to save money to drowning in debt.

In my opinion, the risks in this plan are just too high.

1 comment:

Sanalin said...

You definitely hit the nail on the head with all the problems associated with loans and credit cards and the juggling it takes to keep them straight.

I'd say his best bet is to check out something like prosper.com, a family member who might be able to loan the money, etc. Even if he can only get part of it through more personal sources, it'll take that much burden off of other high-interest methods.

If he's planning on paying it off immediately (within the 6 months) he might be able to manage it even with the 28%. I'd say his first reminder should be to prepare for the worst, financially, because especially right now, banks are trying to squeeze as much money as possible out of everyone, including their good customers.