December 15, 2017

Debt Consolidation Not Always a Good Idea

 

exchange secured debt for unsecured debt

The New York Times recently ran an article in its business section entitled The Risk of Transferring a Car Loan to a Credit Card.  The Times reported noted that several credit card issuers now promote programs in which you can transfer the outstanding balance on your car loan to a credit card.

 

At first blush, this seems like an interesting concept.  Car loans are secured debts, while credit cards are unsecured loans.  If you default on a car loan, you run the risk of repossession, whereas a credit card issuer would have to sue you to collect a default, thereby giving you months to refinance or find additional money.

Further, some of the credit card lenders are offering teaser rates such as zero interest for up to 18 months.

Credit card issuers are desperate for new business.  The great credit crunch of 2008 and new federal consumer protection laws have resulted in a significant decline in consumer credit.  Credit card lending is an extremely profitable business but it depends on numbers – specifically, it depends on borrowers who pay, but who sometimes pay late, thereby racking up late fees and interest charges.

And these late fees and interest charges are exactly why trading your car loan for a credit card balance may not be such a good idea.

If you are extremely disciplined and can pay off the transferred balance in full when interest rates are zero or very low, you could save hundreds or thousands of dollars of interest charges.

However, credit card agreements usually contain “gotcha” provisions that jack up interest rates if you are late, along with hefty late fee charges.  A $10,000 loan at zero percent is one thing, but a $10,000 loan with a 25% interest rate is something else entirely.  You could find yourself making minimum payments for years and never see the principal balance go down.

Further, the psychology of credit card debt works against you.  When you have a car loan, you know that if you start missing payments, you car or truck is going to be repossessed.   Repossession is costly and embarrassing and if you are facing a cash flow shortfall you are likely to do what is necessary to protect your transportation.

By contrast, credit card debt does not have the same urgency.  Since you have the option to pay a minimum payment, and you know that losing the vehicle is months away, it is far more likely that you will end up with a large, high interest credit card debt.

I have not seen these debt transfers yet in a bankruptcy context but one of these transfers would be considered recent use of unsecured debt and could be deemed non-dischargeable if you filed bankruptcy within a few months after making the transfer.

My sense is that this type of transfer deal could make sense for a person with excellent credit, steady income and financial discipline.  Such a person could also, presumably, pay off his car loan early anyway, which makes the credit card transfer option less likely anyway.  My gut tells me that there are no free lunches in life and this looks like a “free lunch” proposal.  So I say “stay away.”

About Jonathan

Jonathan Ginsberg represents honest, hardworking men and women in the Atlanta area who need personal bankruptcy protection. In practice for over 25 years, Jonathan teaches bankruptcy law and practice at legal continuing education seminars and he is a founding member of the Bankruptcy Law Network. Jonathan lives with his wife and children in Atlanta.

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