In a recent article we shared statistics indicating that affluent Americans are more likely to carry credit debt than Americans in the lowest income bracket. The article also shared some tips for paying down this debt if you’ve accumulated more high-interest credit card debt than you intended.
One common strategy for reducing and eventually eliminating credit card debt is taking advantage of an introductory 0% balance transfer offer on a new credit card. The idea is to transfer high-interest credit card balances to this new card with a 0% introductory rate and then pay off the balance before the introductory period expires.
A Smart Financial Move … or Not?
There are pros and cons to this strategy that you should consider before deciding whether it’s a smart financial move for you or not.
The biggest benefit of this strategy is that it allows you to avoid interest charges for a period of time and literally catch your breath. For some people with high credit card debt, making a significant dent in their balances is difficult because a big chunk of their monthly payment goes toward paying interest. The average credit card interest rate is currently about 16%, according to CreditCards.com, but some cards charge even more.
For example, let’s say you’re carrying a credit card balance of $5,000 and transfer this to a new card offering a 0% interest rate on balance transfers for 15 months. For the next year, every dollar you pay to the credit card company will go toward eliminating this $5,000 debt — not a penny will go toward interest. So if you put $334 each month toward paying this off, you’d be debt-free when the introductory period ends in one year.
Questions to Ask
To determine whether this could be a successful financial strategy for you, you need to ask a few questions.
First, do you believe you can pay off the entire balance before the introductory 0% interest rate period expires? Or in other words, in our example, could you afford to commit $334 each month to paying down your entire credit card balance? If not, the interest rate on the unpaid balance will increase to a rate that could be even higher than what you were paying on the original card.
Second, are you prepared to stop racking up even more credit card debt? If you just keep charging more and more on your new credit card, you’ll be right back where you started a year from now, if not in even worse shape. Taking advantage of a 0% balance transfer offer shouldn’t just be used to kick your debt can further down the road.
Third, how much is the balance transfer fee? Credit cards usually charge a fee of between 3% and 5% of the amount being transferred, or $30 to $50 per $1,000. So if you’re transferring $5,000 in credit card debt, you could pay a fee of between $150 and $250 upfront. The card might also charge an annual fee.
Fourth, do you anticipate applying for any other type of loan soon? For example, if you are planning to buy a new home or automobile in the near future, applying for a new credit card could lower your credit score by increasing your credit utilization ratio. In this situation, it’s probably smart to wait until after you’ve purchased your home or car to utilize this strategy.
A Financial Lifeline … or Debt Anchor?
An introductory 0% balance transfer credit card offer could be a lifeline to help you get out from underneath crippling credit card debt. Or it could end up being just another credit card you carry in your wallet that drags you deeper into debt.
Be sure to answer these questions thoughtfully and honestly before accepting such an offer. Give us a call if you’d like to discuss your specific situation in more detail.