0% APR? Watch Out
NEW YORK ( MainStreet) It may not surprise you to learn that, when it comes to your credit score, the game is often rigged. The murky rules by which FICO calculates this number impose increasingly harsh penalties the lower your score goes. A bad score leaves you with increasingly bad options, which in turn reduces your score even further.
To make matters worse, the lower your score, the larger the importance of negative events. Late payments that would barely move the needle for someone with great credit can have an outsized impact on someone whose credit is already poor, making every mistake hurt more than the last.
One area where this is particularly relevant during the holidays is in store financing. We all know the snappy ads, often for electronics and furniture, offering no money down and 0% financing for big ticket items. You buy the computer then pay it off $100 a month for the next year. These loans generally don't require good credit since, after all, if you default they can always send the repo man. It seems like a perfectly reasonable way to spread out holiday spending and not go broke by the end of December.
It's also a mistake.
According to Jeff Hindenach, Director of Content with NextAdvisor.com, taking out these in-store lines of credit can seriously hurt your score in the long run.
"In a lot of cases those loans are called loans of last resort," Hindenach said of in-store financing for big ticket items. "And they can have a drag on your credit score. Is that going to always be the case? No, not necessarily. But those loans are definitely looked at by FICO in a less than positive way."
By a loan of last resort, Hindenach means the types of loans available only to people with poor credit. Another example, he said, is payday loans, which are a huge red flag to the scoring industry. Taking out a loan of last resort signals that you can't get money any other way, which they take as a bad sign.
"These are loans that are basically given out to people who might not have the best credit," Hindenach said. "They're loans where people can't afford to pay for whatever it is that they're paying for, so they take out these loans of last resort. That's why its called 'loans of last resort,' because it's the last resort for people who can't afford to pay for [the purchase] themselves."
"FICO looks at it like the person can't afford to purchase the thing on their own," he added. "They have to take out this loan of last resort, so it makes them less desirable to other lenders... they're basically borrowing against debt."