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How to buy a car with a credit card -- and when not to

It can be a 'rewarding' experience, or a big risk

By Dana Dratch

How to buy a car with a credit cardBuying a car? Chances are you're not going to whip out the plastic.

In the wake of the credit crunch, with many card banks raising interest rates and lowering credit limits, it's not the most practical idea.

Yet some buyers do exactly that. In fact, about one in 19 auto buyers put all or part of their down payments on credit cards in 2008, according to data from CNW Research. The average amount they charged: $3,044.

But their track record with that plastic is not good. Less than one in eight pays off those charges within 90 days.

It's a "bad idea," says Ric Edelman, financial planner and author of "The Lies About Money." "The only reason someone will turn to a credit card is that they lack the down payment and the ability to qualify for an auto loan," he says. "I can't think of any reason to endorse it," he says.

If you can pay it off, charging all or part of a car can get you around the hassles of dealer financing, says Remar Sutton, author of  "Don't Get Taken Every Time." But it only makes sense if you are paying it off immediately.

"For financing long-term, no, it doesn't make sense," Sutton says. "If you're stable and your money's stable, there's probably not going to be a cheaper time" to get an auto loan.

And then there's Murphy's Law. If you're using cards as a stopgap because you're awaiting loan approval at a bank or credit union, what happens if you're not approved?

What do you do if you're charging to earn frequent flier miles or points and you lose your job? Or the card company cuts its points program?

Then there's the practical aspect. "You're also tying up credit that you could use for other things," says Edelman.

What you need to know
If you're determined to use the card for your car purchase, present the plastic and stay away from those cash-advance checks that card issuers may send you, says Sutton. Cash advances often carry higher APRs and, depending on your card company, paying them back can be tricky.

"With most cards, it's a worse idea than drinking fuel oil," says Sutton.

And be aware that dealers aren't fond of the idea of customers using credit cards, either.

Card issuers charge merchants a fee based on how much a customer charges (often 1.5 to 3 percent). And with sales down, dealers often can't afford to give up even part of those narrow profit margins.

"We basically have a limit for all of our companies," says Carter Myers III, president of Carter Myers Automotive, a five-dealership group based in Virginia. For auto purchases, buyers can charge "up to $3,000," he says.

Myers can understand why some buyers might choose to use their cards, if they pay the balance immediately. "You can probably get a nice little chunk of an airline ticket," he says.

"But if you're not going to pay it off, it doesn't make sense," Myers says.

Putting all or part of the down payment on your card, "defeats the purpose of making a down payment," says Donald C. Lampe, partner in the Charlotte, N.C., law offices of Womble Carlyle Sandridge & Rice. "You're trying to be sure that the value of what you're buying is greater than the value of what you owe." But if you're financing the down payment by putting it on credit too, then you don't have any cash invested in the purchase, he says.

As the mortgage industry learned the hard way, it rarely makes good economic sense to finance 100 percent of a large purchase. And auto lenders are cracking down on dealers, says Art Spinella, president of CNW Research.

"Most auto loan lenders don't want to see you putting your down payment on a credit card and financing the rest," he says. "They're putting pressure on the dealers."

And when it comes to accepting plastic for a down payment, "the dealers aren't particularly happy to do it, but if it's the only way it'll happen, they'll do it," he says.

What can go wrong?
In the showroom, fewer consumers are reaching for the plastic this year, says Spinella. But those buyers are charging more and not paying those balances immediately:

  • In 2003, 6.7 percent of auto buyers put all or part of their down payments on credit cards. The average amount they charged: $2,146. And 18.7 percent paid it off within 90 days.
  • In 2007, 7.1 percent of consumers reached for plastic on the car lot. Average amount charged: $2,680. And 14.4 percent paid off the charge within three months.

This year, car buyers are charging higher amounts ($364 more than last year, on average). And 88 percent carry the balance on their cards for more than 90 days.

That means auto buyers are using the cards not just for convenience, or to recoup points and miles, but as a payment method. And that, according to consumer advocates, is a bad idea.

"People are well-intentioned," says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. "They never think they are going to dig a deep financial hole."

But reaching for the plastic in the showroom "is a very risky move," she says.

And it can backfire in several ways.

First, if you charge all or part of your down payment, you have little or no cash invested in the car. That means that you've financed close to 100 percent. So when you drive a new car off the lot and the value drops 20 percent, you already owe more than the car is worth.

In addition, most auto insurance covers accidents up to the amount of the car's actual value. That means if you were to have a total loss, your insurance would still leave you to pay the out-of-pocket difference between what you owe and what the car is actually worth.

For example: If you total a $25,000 car during the first year you own it and the insurance pays off in full,  you'll still owe the lender at least $6,250 -- much more than your average down payment.

If you buy gap insurance (to cover the gap between what you owe and what the car is worth), you have to maintain that coverage until the car is worth less than you owe. That's cash you could have either saved for the down payment or used to pay off that credit card bill.

Another factor to consider: the credit rating.

Any time you put a large amount on plastic and don't pay it off right away, your credit score can take a hit. That's because the FICO score calculates how much credit you have available against the amount of credit you're actually using. The higher the percentage, the lower your score.

Credit card issuers regularly monitor your score. If it goes down, the bank can (and often does) raise your interest rate. That means the charged portion of your new car could wind up costing a lot more than you estimated. Plus, with a lower credit rating, you could pay more (or have trouble even qualifying) for anything else you might need.

And with many credit issuers lowering credit limits due to the tough economic climate, you could find that the down payment you charged three months ago suddenly puts you over your new limit this month. What that means for you is expensive over limit fees and more dings to your credit score.

Chances are, if you're putting a car on your card, you're doing it for emotional reasons -- the car won't be there tomorrow, the sales price will expire at midnight, etc. Instead, think like a bank and shop for the cheapest money you can find.

If consumers have sufficient credit to charge part or all of a car, says Sutton, "100 percent of those people can get a cheaper installment loan at a credit union or bank."

See related: Auto manufacturer credit cards: A deal on wheels?, Can you really afford that car loan?, Can I charge that Acura TL? 

Published: October 20, 2008



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