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Transforming debt can cause issues down the road

A recent article in the New York Times discussed the idea of paying off a car loan with a credit card to get the title to the car faster. The article discussed several pros and cons of the idea, such as the benefit of possibly avoiding repossession on the secured debt by transferring the balance to an unsecured credit card. For people with spotless credit, some commentators say, the idea can reduce interest if a consumer can find a no-interest credit card transfer promotion. But there are downsides to transferring debt.

Commentators say that credit card companies frequently offer zero-interest balance transfers-and some credit cards allow such transfers from car loans. But the zero-interest deal usually has a short timeline for paying off the balance, and high interest can kick in for many before the timeline runs its course.

For many with stellar credit, that may not be a big issue. But, for those who do not have high credit scores, the idea can be dicier. For people who suffer a financial setback, trading the secured debt for unsecured debt could make a bankruptcy petition more difficult.

It is important to note that bankruptcy proceedings involve a consumer's entire financial picture. A person must list all assets, income and debts in a bankruptcy petition, including cars and car loans. Often, a secured car loan will leave a small amount of equity remaining in the car itself for the owner.

Transferring the debt from the secured loan to an unsecured debt will increase the equity on the car, and the full equity on the car may very well exceed the exemption limits in a bankruptcy. Transfers taken before filing for bankruptcy can also be problematic. Creditors may object to the debt, arguing that the debt should not be dischargeable. The government may also investigate transactions before a bankruptcy case for potential bankruptcy fraud allegations.

For those who do not foresee bankruptcy as a potential future prospect, transforming the secured installment debt for new revolving credit can be detrimental to a consumer's credit score, according to the Times article. Many credit ideas may sound good at first blush, but people may run into problems down the line hoping to find shortcuts that will save money. It is important to discuss ideas with financial or legal professionals before jumping in without knowing the potential pitfalls of a transaction.

Source: New York Times, "The Risks of Transferring a Car Loan to a Credit Card," Ann Carrns, March 18, 2013

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