Last Updated Aug 12, 2010 5:54 PM EDT
Zero percent financing deals are popping up left and right these days, with interest rates at historic lows and retailers desperate to boost sales. A friend of mine from college recently wrote to me, asking for some advice on whether to go for this kind of deal. He asks:
I'm thinking of buying a new television and noticed that there are 0% financing options available. I have the cash in my savings to buy the product outright, but at 0% I can easily pay it off in a year without dipping into savings. Are there any cons to this? I don't have many revolving accounts, but I suppose it could hurt my credit score.
The good news is, 0% financing is like free money for 12 months. But there are numerous downsides that can make these offers a bust from a credit perspective. I tapped my friend and colleague John Ulzheimer, the credit guru at Credit.com, for some added advice. Here's the scoop:
Zero percent financing offers from retailers can adversely affect your credit score mainly due to the following:
- You could be ramping up your credit "utilization" percentage. When you finance a purchase from a retailer, they may open a store credit card in your name for the exact amount of the purchase. The store then charges up the newly opened account, maxing out the credit limit. Not good. Thirty percent of your FICO score is based on data that include your utilization ratio, according to myfico.com. This is equal to the amount of unpaid credit card balances as a percentage of the credit card limits in your name. You want to keep this utilization under 10% if your goal is to keep your score well into the 700s. In fact, according to FICO, consumers who have scores above 760 have an average credit card utilization of just 7%. If you pay off the debt in full in month one this won't bang up your score for more than that month. But psychologically we may be tempted to let that balance sit for 11 months (since there's no interest) and pay it in the final month, during which time this "stagnant" debt can cause a continued drag on your score, says John. "Having a maxed out credit card on your credit report for 11 months doesn't do you scores any good," he says.
- You're applying for new credit. A credit inquiry by a retailer can hurt your credit score, especially if you are requesting new credit several times in a short period of time. The inquiry will stay on your report for up to 2 years and can hurt your score for the first 12 months, according to John.
- You're opening up a new account, which will eventually be reported to the credit reporting agencies. "This lessens the average age of your credit file," says John. The length of your credit history is about 15% of your credit score.
A better alternative? Since my friend has the money (and I would add that he should only make this purchase if he can afford to dip into savings), he may want to pay for the TV using a rewards card that's already in his wallet. And of course, he should pay off the debt in full when the statement shows up. This way, as John says, "you can leave your credit report and score out of the equation."
Photo Courtesy Lee Jordan's Photo Stream on Flickr
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