Credit Traps and No Free Lunch Theory

My first post in my credit score blog series focused on monitoring and tracking credit score, and my second post focused on tips for improving your credit score. This third post in the series walks you through the common traps that you may encounter. If you are not careful, you could inadvertently hurt your credit score – which detracts from your financial goals. After this post, I will move on to other interesting personal finance topics.

Acropolis of Athens, Greece, 2012

Trap 1: The Enticing “0% Financing” and “0% Balance Transfer” Credit Card Promotions

I just got another “0% financing” advertisement from Home Depot today. These promotions sound so attractive! As a cardholder, you get to make any purchase without paying interest for the next 24 months. There are no shortage of 0% financing and 0% balance transfer credit card promotions out there. Frequently furniture retailers offer this to consumers who just paid the majority of their cash into their home and don’t have much cash left to purchase furniture. In order to take advantage of the 0% financing, you only need to pay the minimum balance due in order to avoid the finance charges (could be as low as $25 per month). This means you can effectively borrow for free and invest at a higher rate of return, right?

My “No Free Lunch Theory”

If something sounds too good to be true, it probably is. There must be a string attached to this seemingly great deal, right? Yes and No.

Why there isn’t a string attached? As long as you keep paying the minimum amount due and abide by the lenders’ requirements, you can avoid any interest and late payment charges. As long as you follow the rules, your lender should too.

Why there is a string attached? Taking advantage of this seemingly attractive offer could hurt your credit score. To illustrate, if you decide to take advantage of this promo and borrow $5,000 and pay $25 each month and pay off the remaining balance at the end of 24-month term, your average balance for the next 24 months will be $4,524. This will meaningfully increase your credit utilization ratio. Recall from my prior post, credit utilization rate accounts for 30% of the credit score – the higher the ratio, the lower your score! Therefore, if you have the cash for the purchase, I would pass on this type of promotion.

Franklin Zoo, Boston, MA 2015

Trap 2: Purchasing A Car with Auto Loan Instead of Cash

When you purchase a new or used vehicle, car dealers often will offer you an attractive financing option (e.g. 0%, 0.9%, 1.9%, etc.). These rates are typically lower than your mortgage rates. Wouldn’t it be great get an auto loan and pay down your other debt (e.g. mortgage, credit card) at higher rates first?

One way to evaluate whether you should pay cash or borrow, think about the follow aspects:

  • Alternative use for your cash: what can you do with the cash to invest?
  • How does the loan affect your credit score?
  • Are you willing to monitor the payment and balances and even take the risk of missing on a payment?

I recommend paying for your car with cash. Because if you start an auto loan, it will increase the “amount you owe”, the factor that accounts for 30% of your credit score. In addition, running a credit inquiry could (temporarily) hurt your credit score as well.

If you do decide to get an auto loan, always make sure you are paying on time. If you prefer to use autopay, be careful when the first payment is set (I would also call the lender to confirm). If autopay is set incorrectly, it is possible to get off cycle and unintentionally miss a payment. I would avoid the hassle of auto loans altogether if you have the cash.

Trap 3: Closing No Longer Used Credit Cards

As you go through your purchase needs and take advantage of the initial credit card opening promotions, it is common to cycle out of certain cards as they became less attractive (e.g. smaller rebates) than newer cards. In order to reduce the number of cards you need to manage and store, does it make sense to close the unused cards?

Before you close your next unused card, think about how this will impact your credit score. When you close an account, it will decrease your credit capacity and effectively increase your credit utilization ratio. Remember, the credit capacity is the total amount you are able to borrow across all your credit lines, so you want that number to be as high as possible. If your ultimately goal is to maintain a top credit score, consider leaving the account open (and storing the cards in a safe place).

The Greek Parliament, Athens, Greece, 2012

Bonus Tip: Credit Quick Fixes

Lender typically report a late payment to the credit report agencies after it is 30 days past due. If you are ever late on payment, call your lender and ask whether they have reported your late payment to the credit reporting agencies. If your lender has not reported it, your late payment won’t show on your credit report.

If you have very good or exceptional credit score, kindly ask the representative on the phone to reverse the late fee (chances are they would as they want to keep you happy). If your lender has already reported the late payment, try to negotiate to see if you can have them modify that record and count it as current payment. Most lenders are reasonable and it never hurts to ask.


Dear readers, have you fell for one or more of these traps? After reading this post, what would you do differently to protect your credit score?


1 thought on “Credit Traps and No Free Lunch Theory”

  1. Great article Weina. Glad to know about the credit utilization with respect to the zero monthly payments. I also love your tip on simply calling the vendor to see if they can reverse the charge or change its categorization. Thanks. Keep em coming!


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