Getting a new card for a big purchase is not likely to spook your other card issuers into lowering your limits. However, you could see your credit score drop for a while, and the new debt may leave you vulnerable to financial shocks.
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Dear Keeping Score,
I’m looking to finance an engagement ring (approximately $10,000) with a 0 percent APR credit card over 12-15 months. I have the cash on hand, but would like the opportunity to let that money earn elsewhere. I have $58,000 in available credit over three credit cards. My concern is if I put $10,000 on a $15,000-$20,000 credit card and carry the balance my other credit card issuers may see the high utilization on the new one and drop my credit limits. Is this likely to be true? -Ryan
Free money? Sign me up!
Everyone loves “free” money – but as you are aware, it’s not truly free. Your concern about having your credit limits reduced on your other cards is valid, but not your biggest worry.
Credit card issuers have the right to reduce your credit limits at any time for any reason. And they don’t have to warn you that it is going to happen. I will tell you, though, that credit limit reductions are relatively rare. You are a customer after all, and the other creditors want you to use their products, too.
I’m more concerned about the impact on your credit score and your increased vulnerability to unanticipated financial shocks. So, let’s look at the pros and cons of your opportunity.
- A $10,000 ring with no cash out of pocket.
- Some extra bonus cash from investing the $10,000 and making it work like a dog while you put your feet up.
- Your credit score takes a hit due to high credit utilization. Utilization is figured based on the debt-to-limit ratio of all your cards combined, as well as each individual card. The individual utilization on your new card will be high for a while, but your overall debt-to-limit ratio may not increase to a score-reducing level – more than 30 percent, for example – depending on the balances on your other cards. (Overall utilization carries more weight under FICO’s traditional model.)
- Your score could also be affected simply by adding the new account and having it shorten your average age of accounts. And you’ll likely lose five points or so from the hard inquiry that will be generated when you apply for the card.
- You’ll have to make a minimum payment on the balance each month, so that could eat into any earnings you receive while investing the $10,000. Most major issuers charge minimum payments of 1 percent of the balance plus any interest charges (which wouldn’t apply in your situation) and fees.
- Using leverage increases risk. This is a maxim of finance. For the next year, you’ll be more vulnerable to financial surprises, setbacks and misfortunes than if you had paid the bill and forgone the extra investment income.
The good news is that you would eventually recover from any credit score damage as you make on-time payments toward the balance. But the gain, while real, may still be too small to warrant the risk. Perhaps a middle ground would be to finance part of the purchase. Keeping your card utilization rate under 10 percent will help your FICO score and reduce any leverage risks. To illustrate, people with a score of 750 or higher often have a card utilization of 7 percent or so.
Some other questions you may want to consider are: Where do you stand with your other cards? Have you pulled your credit report recently to be sure there are no errors? Do you have a solid plan in place to pay off this purchase within the no-interest period?
Also, it is important to know if the card you are using is truly a zero percent card or if you are talking about a deferred interest promotion. With a zero percent card, you will not be charged any interest for a set timeframe; your reference to paying the card off in 12 to 15 months seems to indicate this timeframe. In that case, if you fail to pay off the card during this grace period, your remaining balance will be subject to whatever the stated APR is on that card.
However, a deferred interest promotion means failing to pay off the balance by the deadline will result in interest being retroactively charged on the original purchase amount. Only about 75 percent of deferred-interest offers are paid down in full before their promotional period ends, according to the Consumer Financial Protection Bureau.
That means about 25 percent of such offers resulted in a big interest bill surprise. This type of arrangement is typical of retail store cards. It is important to understand exactly what you are signing up for here, just in case something happens (like life!) and you are unable to pay off the balance in time.
In the end, you get to decide if the earnings you will gain from having your money work for you while you pay off this purchase are worth the scoring hit and the overall financial risk you may be taking.
From a personal point of view, unless this ring is a big unexpected surprise, you might ask your intended which course of action she feels most comfortable with. Partnership building is best begun at the beginning.
Remember to keep track of your score!