Monday, September 17, 2012

Do Balance Transfers Always Make Sense?

Balance on this!
If you've ever carried a balance on a credit card, you've probably also considered setting up a balance transfer to "hide" that balance and not pay interest on it for a while. I don't know about you, but I receive a handful of balance transfer offers in the mail every month, and those "0% APR for 12 month" offers can be very tempting.

But hang on a second. Does it always make sense to transfer a balance from one credit card to another, even at 0% APR? Let's take a look at the fine print.

I was perusing just such an offer from Discover Card when I saw that the balance transfer charged a 5% immediate fee to facilitate the transfer. Big deal, you might say. If I'm being charged a 19.99% APR on another credit card, surely paying 5% instead makes more sense.

The problem comes from just how that interest is charged. As I stated, the 5% charge is immediate, but what you might not realize is that the 19.99% charge is spread out over the year. What does that mean in real figures?

If you transfer $1,000 to Discover, you will immediately pay a $50 fee to do so. This balance will not be charged interest for a year, however.

If you kept that $1,000 on the original card at 19.99% interest, you would only face an interest charge of $16.66 the first month. This is because while the interest is higher, the charge is then divided across the 12 months. Therefore, your monthly interest charge equals $1,000 X .1999 / 12 = $16.66. With this being the case, it would take over three months for that $1,000 on your original credit card to cost you in interest what you'd be paying immediately with balance transfer.

What should you do in this situation? It depends on how quickly you can afford to pay down this debt. If you think you pay an extra $333 per month towards the principal, it makes more sense to keep it on the original credit card (particularly since the interest will be reduced with each payment). If, however, you think you need to pay this amount down over the course of a year, then the balance transfer is the better option.

So what should be your takeaway? Balance transfers are the Trojan Horses of personal finance, and, in this case, it makes a lot of sense to look this gift horse in the mouth.

Photo by SeeMidTN.com.

1 comment:

Christa said...

Great breakdown! Aren't credit cards aggravating?