Sunday, December 19, 2010

More About Balance Transfers

Balance Transfers are a good way to reduce debt faster
As I said yesterday, a large part of my success in paying down my debt was using balance transfer offers.  I can't stress enough how much faster you pay off your debt when you transfer a high interest balance to a low interest one, as long as the transfer fees don't eat up your savings.

Moving from a higher fixed interest rate to a lower fixed interest rate is generally a good deal
For example, if you have $15000 on a 22% card and the transfer fee is 5% to change the rate to 10%, at $300 a month paid toward that card it would take you 136 months to pay it off at 22% and 70 months at 10%, including the $750 you will pay in transfer fees.  

Teaser rates can also help pay down your debt faster
I realize that most offers nowadays aren't a fixed rate forever, they're usually a teaser rate, then a higher rate later.  For instance, today Discover is offering 0% for 18 months, with a 4% transfer fee, then a rate that ranges from 12% to 23%, variable.  If you can pay off your balances in 18 months, then it's a savings on any rate 6% or higher.*

If you can't pay off your balance, then it's a bigger savings at rates of 6% or greater until the rate resets.  Therefore it is a good deal if (a) you can pay it off rapidly after the 18 months or (b) you can transfer the balance again before the higher rate kicks in.  You can calculate (a) by taking the current balance of the loan, subtracting out the payments you will make over the next 18 months, then running that number through a balance calculator that shows you total interest paid, using the number of months after the 18 month period is up that it will take you to pay off the loan as the number in the debt free deadline.  (b) is pretty much a matter of looking at your credit score and guessing.

If you can pay off your balance in less than 18 months, it may or may not be a savings.  You can calculate whether it is a savings by running it through a credit card calculator like this one, using your current interest rate and the time it will take you to pay off the loan.  Then compare the total interest paid to the cost of the balance transfer fee.

It's no fun, but it helps in the long run
As I said, I did this pretty much constantly for the first two years that I was paying down debt, until I got a 3% for the life of the loan offer from Amex and could transfer all of my credit card debt there.  It got really tiring; I can't tell you how happy I was to pay off my last revolving debt on that Amex .  But it saved me a ton of money over trying to pay down the cards at the original rate.

* Because the balance transfer fee comes out of the original total, and credit card rates are compounded daily or monthly based on the debt at the time of calculation, you don't pay more in interest until you reach a 6% interest rate.  (It's actually a number greater than 5.5 and less than 6, so I rounded up).

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