This is a guest post from Andy Jolls, a former FICO executive and founder of VideoCreditScore. If you like what you see here, please consider checking out his videos and/or subscribing to his RSS feed.
A few years ago, a friend of mine was engaged in 0% credit card hopping. She had accumulated $20, 000+ in credit card debt after graduate school and was constantly opening up a new card to avoid interest charges. The logic: people see these 0% credit card offers and think “Wow, I can use those to make a dent in my debt.”
This line of thinking should, however, lead to two questions:
- If credit card issuers are making these offers so often, how can they be making money?
- Are there any negative impacts of card hopping, such as damage to your credit score?
The 0% reality
The truth is that most people weren’t careful enough to really take advantage of the “free loan” offered by 0% credit cards. The reality is that most folks transfer their balances and then see their card balances stay about the same, or even grow.
This is probably because people keep putting off their payments knowing they can hop to the next 0% offer. While I could dig for data to support this view, I’ll just stick with some basic logic…
Credit cards essentially offer 30 day “free” loans, and yet they generate billions in interest payments to card issuers every year. It thus stands to reason that a six month 0% offer could easily lead to a profitable business — and it often does.
Effects on your credit score
On the credit score side, the impact of card hopping is probably unknown to many “hoppers.” Credit card hopping creates several different issues. First, by opening so many credit cards, you are impacting the inquiries piece of the credit factors pie. Lots of inquiries means lots of risk and thus a lower credit score.
Second, if you are opening these cards, doing a transfer, and then closing the cards, you are never building aggregate available credit. You could have had 20 credit cards in your life, yet only have $1000 worth of available credit at any given time. People with great credit scores often have total credit limits in excess of $20, 000 meaning that you’re usually using just a small fraction of their available credit. Since credit utilization accounts for 30% of your credit score, this can have a big impact.
Finally, the credit history portion of your score will be damaged, as it favors people who have had a few credit cards for years and years as opposed to consumers with lots of cards that have only been open for six months. This is why older people often have better credit.
Ask for a better rate
Another possibility is to use a 0% balance transfer offer as leverage against your current card issuers. Go ahead and contact your creditors and tell them that you have an offer to switch to a 0% card and that you want your interest rate lowered. You may be able to negotiate that 24% rate down significantly.
The 0% landscape
So… If these 0% credit card offers are so profitable, why have they begun to dry up? Well, the current economic climate has transformed consumers who struggle to pay off their debts into defaulters, cutting into profit margings. Thus, credit card issuers have tightened up and 0% cards have gotten harder to find — for now.
Eventually, however, the economy will recover. When it does, zero percent offers will once again become commonplace. As tempting as these offers might be, you should resist them unless you have a firm repayment plan in place. While getting out of debt is an admirable goal, you won’t make any progress without a plan.
I did the 0% arbitrage for a while to make money, but it was such a pain in the neck to ensure that terms and conditions didn’t change and to ensure payments were done within the grace period etc, i decided it wasn’t worth it to me.
the ding on applying for new is really minimal and short term. Maxing utilization also doesn’t matter if you aren’t getting a loan for anything else. Nor is the impact on credit score that affects your interest rates, because presumably you will pay it off before the promo due date.
#11 Andy) How do we know what is myth and what is fact if the credit reporting agencies will not disclose the formulas they use?
And Nickel) I know for a fact that Capital One was not reporting the credit limits on normal everyday credit cards (upwards of 50 million accounts), though they have admitted to changing this practice. I personally saw this on my report. I read that CapitalOne was hurting scores by 40-50 points (on average) for everyone who had a CapitalOne card in their wallet by their practice of not reporting the correct “maximum limit”.
Of course, if you decide to close your credit card account after reading this, be forewarned: it will hurt your credit score to close a credit card account, and that is no myth.
Obviously the credit agency’s formulas are not complex enough to understand that just because I close an account doesn’t mean my credit is reduced. My personal CREDIT is actually increased by the reduction of the LIABILITY of a credit card. The system is “gamed”…
*sorry for ranting*
@Andy: Exactly… without discipline – the debt monster will never be eradicated! 🙂
poster LOL, some great points. One myth though, is that you have to carry a balance. Rather, there’s a distinction, you have to use your cards, but you don’t need to carry a balance from month to month. Where the system isn’t flawed, is that you can have a great credit score, without ever having to pay a cent of credit card interest.
Matt, peer to peer lending is a good solution for consolidation for some. For others, consolidation loans just wipe their credit cards clean…then a year goes by and low and behold, they now have their consolidation loan and new credit card debt. As we both know, discipline is the key.
LOL: Most credit card issuers *do* report your limits to the agencies. The primary exceptions are cards with “no preset spending limit,” but even here the cards do technically have a limit, and many issuers do report it.
#7 Jared: A high credit score can only be had by “playing the credit game”. You must have credit cards (with a balance) that show a long history of making payments. You can’t have “too few revolving accounts”. You can’t have “too many inquiries” (so don’t shop around), etc, etc. Of course they will not tell your how many “too few” is.
A lot of the necessary data is missing from credit rating agency’s records: such as for “Proportion of balance to Credit Limit”. They do not know the credit limit on your credit cards. If you have a $10k limit, and the highest balance you’ve ever had is $1k, then the credit rating agency thinks your limit is $1k (they only see the balance as reported by the lender). If you charge $1k, they think you’ve 100% maxed out the card (which will hugely dent your credit score) — though you’ve only used 10% of your available credit with that lender.
Lenders (CC companies) use this knowledge to hurt your credit rating as much as possible — they wont report ‘credit limit increases’, but they will report ‘credit limit decreases’, etc. Lenders do this because they know that they can get more money from you when you have a lower score. Tie this with the clause in most CC contracts that your APR will increase (universal default) if you score falls below an arbitrary threshold and you are screwed.
A few years ago I paid my student loan off in full, and my credit score dropped! The next month Capital One, my former CC company, sends me a letter saying my fixed 5.9% APR card (that I had for over 5 years) is going to now be variable starting at 14.9%. Also note that Capital One is one of those companies that didn’t report your credit limit (though they claim to do so now).
If you play with snakes, then expect to get bitten.
Unfortunately, you have car insurance companies that quote their insurance rates based on the ridiculous and manipulated “Credit Score”. What does someones’ credit score have to do with their driving risk? Where does this slippery slope end?
The entire system is broken and corrupt. Hopefully the previously mentioned legislation can reform this mess.
Harkens back to the old “If It Sounds Too Good To Be True…” adage (re: 0%). Agreed that high schools should add a mandatory “Credit/Loans” module to the curriculum.
@5 I agree somewhat with what you’re saying, But if you look at the industry as a whole people with lower scores tend to have defaulted on debt in the past and so it stands to reason they will again in the future. It may not be that they don’t have the ability to pay, but perhaps in some cases they feel they don’t have to(like my sister who shall remain nameless). Your pal with the 820 obviously never defaulted on any loans in the past, so they find a way to prioritize and payback one way or the other. Also, if they apply for a loan with no job, then they still won’t get it, 820 or not, because they have no way to pay it back. As long as they keep working they will be ok. That is the reason companies do employment verification.
For a spell I tried to consolidate my remaining $6,000 in credit card debt to a card w/0% interest and no balance transfer fee… but I could not find one. Also, part of me wanted to cut ties w/credit card companies altogether – even before the debt was gone.
So what’s the answer?
I used Lending Club to consolidate my debt. After subtracting the $80 fee to transfer, the amount of interest I’ll save over the life of the debt equated to be upwards of $500 (the loan also consolidated some high interest auto loan debt.)
Now I am paying no longer paying credit card bankers, but instead am paying individuals… like Nickel! 🙂
#1 Austin: What are the high schools supposed to teach? That a company (FICO, aka Fair Isaac Corporation) has an internal formula that they will not disclose (that probably changes daily) that magically creates a number that is called a “Credit Score” — and that their records are full of mistakes and inaccuracies that they base this number on…
The problem is not the consumers — the problem is with other companies (lenders) putting ANY FAITH AT ALL into FICO’s scoring.
If anything, all a FICO score tells you is how smart the guys “previous lenders” were. If the previous lenders lent money they shouldn’t have, then the consumer gets a lower score when they can’t pay. It in no way indicates if a person has an ability to repay a loan — specifically since it does not take into account a person’s INCOME, or Debt-to-Income ratios…
I know people who have 820+ credit scores who have debt up to their eye-balls and live paycheck to paycheck — see my point?
This article is totally out of date, based on the old rules. With the CARD act coming into effect, 0% APRs are very unlikely. As you said, they make their money on interest payments (say from people charging purchases on a card with a 0% Balance Transfer, and paying interest on the purchase amounts). However, with the CARD act, credit card companies will have to apply the payments towards the interest-accruing purchase amounts first. So their profit from interest goes bye-bye.
That means that it is highly unlikely you’ll see the sweet 0% balance transfer offers that used to be so prevalent. There will be some once someone figures out how to work around the new rules, but the offers will likely be a shade of their former selves.
0% interest is similar to the gift card phenomenon. The seller of the gift card hopes at least 10% lose or forget to use it. It’s part of their model. The 0% CC issuer hopes a good portion exceeds the extended grace period.
It’s a volume game, just like everything in life. Ask 100 women out, even if you are kinda unattractive, and I bet at least one will say yes! 🙂
So True. 0% offers are great once you are 100% committed to getting out of debt. They are just delaying the inevitable otherwise.
I used two zero percent transfer offers to finish off my credit card debt a little over a year ago. My credit score tanked once I opened the two new accounts, even though the amount of debt I had was unchanged. Opening too many new accounts in a relatively short amount of time is viewed as a sign of financial instability. I didn’t care about the drop – my goal was to pay the debt off and I knew my score would rebound after that, but a person really needs to be careful when playing the credit hop scotch game. It can do more harm than good if not managed correctly.
Why high schools don’t teach a class about credit scores is beyond me. Too many people are losing tons of cash because they have no idea how their credit scores work.
Great post.