Are you in debt but have never thought about paying it off faster by reducing your debt obligations? You should…
I am still on the edge about whether or not to do balance transfers. I have three credit card that have a total balance of $2037.84. I am wanting to it off completely within 6-8 months. My annual APR’S are 20.24%, 10.25%, and 22.90%.
I have no doubt that I will be able to pay off within 8 months and I always pay my cards on time.
I just can’t figure out how much I would pay for the transfer fee (whether it was 3% or 5%) and how much I would actually save with 0% interest on balance transfers.
Though the precise calculation needs a fair bit of specifics that aren’t provided here, we can make some assumptions and still make this exercise worth while. We will assume that the total balance is spread out on the three cards and therefore having an annual APR of 17.80% with a rough monthly interest rate of 1.48% (I know this isn’t technically correct, but this is adequate for making the point). We will further assume that Danielle, the reader, is going to pay an equal amount for 8 straight months to pay off the entire balance.
3% Balance Transfer Fee
If she signs up for a 0% balance transfer credit cards having a transfer fee of 3%, she will pay $61.14 on her balance of $2,037.84. Her balance then becomes $2098.98, and she will have to make $262.37 each month to pay it off.
Will the 0% balance transfer win out? Let’s see what happens if she makes $262.37 a month on her cards with interest.
Again, assuming an interest rate of 1.48% per month:
After month 1: her balance will be $1,805.63 (Original balance of $2037.84 + interest minus her payment)
After month 2: $1,569.98
…
After month 8: $81.03
So, after 8 months and making the same payment, she will still have $81 in her account. Therefore, we can conclude that a 3% balance transfer fee is worth taking.
What About 5%?
If the balance transfer fee is 5%, her total becomes $2,139.73 or $267.47 a month for 8 consecutive months. Using the same method, she will be left with $38.05 after 8 payments at the same interest rate.
Either way, signing up for a 0% card works out.
Wait, The Math Makes No Sense
You may be wondering why you actually have less of a balance with a 5% balance transfer fee up front. This is because in the calculation, I’m assuming that Danielle can muster up $5 more towards principle every month if she opts for a 5% balance transfer fee. Though I don’t know how much Danielle makes, it’s safe to say that she can find $5 more each month from somewhere.
Sometimes, It’s Not Just the Numbers
Even though the math makes sense, don’t jump in just yet, as Danielle might be better off keeping her cards the way they are. Personal finance is a little mathematics coupled with a dose of psychology. As you can see from the example above, the more you are able to pay each month, the lower the balance. You may feel like you are getting ahead by signing up for a 15 month 0% interest rate deal, but if it means delaying your debt repayment and more splurges, it probably isn’t worth it.
On the other hand, if paying 18% APR makes you mad and allows you to cut out a luxury or two to pay off your debt (or better yet, find some ways to make a buck or two extra), what harm is there to pay more interest temporarily?
Know yourself, and which way works for you will become clear.
{ read the comments below or add one }
The Rat, before you switch from a 4-5% to a lesser % please do the math VERY CAREFULLY! I did the math on one credit card and with the now 4% transfer fee cost I would have saved only $11 over the course of the rest of the payments. Here’s why I think I can give advice on this, I’ve lowered my credit card balances from $9,000 in Sept 2010 to $2000 right now!
I called LLBean Visa to ask when my 3% balance transfer expired. Guess what? They said “never.” Somehow when I transferred about $2,000 I forgot to ask the end date although I know I would not have done it if it were not for at least 9 months to a year. They double-checked and my balance is still only getting a 3% interest rate! I’m down to $900 and paying it off as fast as I can but I really appreciate paying only 3%. On the other hand I called Sears to ask how much the interest would be after a balance transfer expires and they said, get ready, hold on to your hats:
27%
Yes, you read that right. I said, “you have got to be kidding me!” and I will never use my Sears card again. I have had one since 1979 and they have the audacity to charge 27% interest with my excellent credit rating? They will never get another dime of my money in any other form than cash or my Amazon.com visa which gives me % back on purchases.
Most credit card interest rates are very high, especially if you are young and just starting to build the credit history that the credit bureaus base your score on. In most cases, store cards charge higher interest rates than Mastercard, Visa, or American Express, or Discover. Discover is offering 5% back on all purchases(up to a certain amount), and they will double that amount for the first year that you have the card. It is important to remember to use the cards that you have every so often because they can be closed if they are inactive, and this harms your utilization rate and that lowers your credit score. It is also important to read the terms and conditions because some banks that issue these credit cards can have lending policies that can cost you a great deal of money for fees and other charges unless you are careful and aware of exactly what they expect of you. READ THE VERY SMALL PRINT!!
Sadly, gone are the 0% (intro for 6-months) interest card that has no transfer fees. Years back, before the economy went south, we would get these offers pretty regularly.
Check the small print and if your credit is really good, you may be getting these transfer fee-free offers in the mail.
We used them when we had some balances that we moved from 0% card to another 0% card, until we had the resources to cover the debt in full. Worked great for us, but resulted in us having three extra cards we never use that no doubt impact our overall credit score.
It seems like a no-brainer. At least it did to me. On the one hand, I pay 17%. On the other, I pay 0%. But PLEASE read the fine print. You always make your payments on time, and plan to continue to do so. But what happens if an unexpected medical problem crops up or you lose your job and you are unable to make those payments? Will your rate ratchet to 30%? Now suddenly you’re in real trouble.
The banks make money on these offers. So before you take the plunge, make sure you have a contingency plan .
Thanks for sharing everyone. There’s really no right answer when it comes to credit cards because psychology plays such an important factor in what will ultimately make more sense financially.
Pick the way that’s the most responsible to you and it will always be the right way to go.
We used 0% balance transfer offers to pay off our debt. It worked for us. From what I understand, they are getting fewer and farther between. But, it worked for us and just reigning in our spending was insurance for staying within our budget. 2 years later and we are still consumer debt free. Utilizing those offers can lead to results if you use them right.
I feel like using a 0% balance transfer card is just delaying my freedom. I rather pay more interest but keep my spending in check and pay it off quicker. That’s why I like cutting up my credit cards. I won’t get 1% rewards back, but I definitely spend much less.
It works for me.
have you seen the new credit card statements? they now finally show people who only make the minimum payments what the consequences are if you do this. they show how long and how much you will pay if you only make the minimum payment.
although this will not deter everyone from making the minimum payment i hope it helps some.
I don’t understand why most people think badly of getting these 0% cards. It’s just another way to get back at the credit card companies for changing interest rates once your intro period is over.
When it’s within the rules and you end up making money from it, why not?
I have used credit cards that had promotional offers of charging a one-time 1% transfer fee but included a 6-month period of only 1.9% interest. Under these circumstances, it could easily be a feasible way to transfer debt from one ares (say a line of credit of even 4 to 5%) or a credit card charging a higher interest rate.
In the end, the best situation is no debt, but at least this strategy can possibly save 6 moths worth of time for plowing funds on debt charging lower interest.
Nice post.