Monday, January 27, 2020

Balance Transfers - Throwing You a Life Ring or Anchor?

Should you use a balance transfer to get out from under a credit card crises?
With interest rates at an all-time low, many people are considering using balance transfers to get out from under high interest credit card debt.  Banks, seeking new avenues for investment, are offering pretty amazing deals - some offering no interest for 21 months(!!).  Should you take one of these balance transfer deals?  It depends.  But the first thing you should bear in mind is if you're considering a balance transfer means you've really screwed up your finances and it's time to start taking life more seriously.

You should never carry a balance on a credit card - all the experts say this, and it is true.   Yet 70% of Americans do so, and probably 100% at one time in their lives.   I did it - chances are you did, too, or will.   In retrospect, it was idiocy - charging things I could not afford, and then paying staggering interest rates (10% to 20%) every month for things I consumed such as food and gasoline.  When you do this, all you are doing is taking a dollar and turning it into ninety cents.   Depending on the interest rate on your card, and how long you take to pay it off, it could be as bad as turning a dollar into fifty cents.

And who in their right mind thinks turning a dollar into fifty cents is a bargain?

But it's too late for that.   You've gotten yourself into a situation where you have this intractable credit card debt that just won't go away.   If you are poor, it could be just $5,000.   If you are middle-class, it could be $50,000.  If you are wealthy, it could be $100,000 or more - a personal credit card crises is a game anyone can play at any income level.

The problem is, of course, that the victim played the "monthly paycheck" game or "paycheck-to-paycheck" as folks like to posit themselves (as victims, natch!).   They've divided up their paycheck into little cubby-holes labeled "mortgage" and "car payment" and "credit card bill" and so on and so forth.   They spend money and so long as all the payments are being made, they think they've got this covered.  But eventually, credit card debt climbs up, and interest takes up more and more of the monthly payment, and eventually credit limits are reached and exceeded.   Some take on a second or third credit card as a "solution" to the problem - sort of like dousing yourself with gasoline and lighting a match.

The real problem is in spending, and oftentimes in marriages, money isn't talked about - too much.   Each partner goes out and spends and measures their spending by comparing their lifestyle to their neighbors and friends - who are just as broke, or might make an awful lot more money than they do.   So charging a $5 coffee every day is no big deal.  Buying that new sweater at the mall "on sale" is no big deal.   Buying that new fishing rod that you've always wanted (at this price, who can afford not to buy - right?).   That's how it happens.

So it seems like a good deal to take one of these transfers.   It will give you a "breather" for 12 months, right?  Maybe as much as 21 months!   Finally, all of your monthly payment will go to principal and not most of it toward interest!.   Sounds appealing, but there are a lot of pitfalls - which could end up making your financial situation worse not better.

Let's take a look at two such offers from a major credit card company.  The one on the left offers "points" while the one on the right offers "no annual fee or penalty rate" - although the rates quoted are pretty much near that, particularly in an era of single-digit interest rates:

 Purchase Rate

0% introductory APR for 12 months from date of account opening; after that your variable APR for purchases will be 16.24% - 26.24% based on your creditworthiness.*
Balance Transfer Rate
0% introductory APR for 15 months from date of first transfer; after that your variable APR for purchases will be 14.99% - 24.99% based on your creditworthiness.* Balance transfers must be completed within 4 months of account opening.*
Balance Transfer Rate

0% introductory APR for 21 months from date of first transfer; after that your variable APR for purchases will be 16.24% - 26.24% based on your creditworthiness.* Balance transfers must be completed within 4 months of account opening.*

If you transfer a balance with this offer, interest will be charged on new purchases and unpaid introductory balances after your 0% introductory APR on purchases has expired, unless you pay the entire balance (including any transferred balance) in full each month by the due date.
Balance Transfer Fee
Either $5 or 3% of the amount of each transfer, whichever is greater, for each transfer.*
Balance Transfer Fee
Either $5 or 3% of the amount of each transfer, whichever is greater, for each transfer.*

Note the terms are somewhat different, and I suspect the card on the left is harder to get.  In order to get one of these deals, you have to have a pretty good credit score.   If you are over your limit and have already missed payments on your old card, or worse yet, been late on a mortgage payment, too bad for you.   But note the hand-grenade in the deal - if you don't pay off the balance in 21 months, the usurious interest rates kick in on the unpaid balance you transferred.

They are hoping to break even by charging you 3% of the balance owed, just for the transfer.  So you transfer $10,000 and you owe then $10,300 right off the bat.   If you can make 21 payments of $500 each, you might be able to pay this off in the time allotted.   They are counting on you not doing that.  And your spending habits and history gives them good reason to believe that.

The big problem with a balance transfer is not only the fees involved - sometimes as much as 5% of the balance - plus the suicidal interest rates should you not pay off the balance within the allotted time period, but the temptation to go out and spend more money.  You transfer the balance of one credit card to a new credit card and now your old credit card has a zero balance. If you rack up debt on that and also have the outstanding balance on the new card, you are now in twice as much hot water as you were before.

Not only that, they are offering 0% interest on new purchases for the first 12 months, and also baiting the trap with "rewards points" in the left-hand offer.   So you might be tempted to think that charging more money on this new card is a smart move.  After all, 0% interest, that's like free money, right?  And you can "play the float" and "invest" that money  you would have used to pay off your credit cards on stocks or something, right?   "Opportunity Cost" rears its ugly head and its bag of lies.  The sad reality is, you have no money to "invest" and there is no "opportunity cost" involved and you'll never get out of debt believing such bullshit.

And you will rack up debt on the old card if you don't change your habits.  In a way, it is like people who want to contribute to a 401(k) plan, but don't reduce their spending in another part of their life.  Yes, you can put $100 a month in your 401(k) plan, if you cut some $100-a-month expense from your life (such as cable TV or an expensive cell plan, or eating out at restaurants).  If you don't make that balancing act, then you just run up credit card debt - maybe how you got here in the first place!  I've seen it done!

The banks will tell you that a balance transfer is "a smart move" and a sign of financial acumen.  If you're considering such a move, it is a tacit admission that you are a complete fuckup when it comes to your finances and it's time to start having a serious conversation with your spouse about spending.   A balance transfer can be a life ring, or it can be an anchor that pulls you down to the bottom.

If you decide to go this route, the first thing to consider is which offer to take. They're an awful lot of offers out there and you should consider them all very carefully and read all the terms.  Most have a balance transfer fee, on the order of 3% or more, which represents a substantial portion of the balance.  Most offer 0% or low interest rate for certain number of months, but then at the end of that period, interest rates can be jacked up as high as 15 or 20%.  If you don't pay off the balance within the specified time period, you may never be able to pay off the balance at the high interest rates they offer.

The banks are counting on this.   They figured out long ago that they can make more money ruining their customers financially than by helping them.   They offer tempting things - car loans, leasing offers, credit cards with "rewards" and high interest rates, and when you bite on these and lack financial discipline, well, you can easily get in over your head - most of us do at one time in our lives or another.   Under new bankruptcy laws, they can still get paid back the principal they loaned you, after having collected interest for a number of years.   So far from being a "risky loan" such offers are actually pretty secure.

And they are betting you won't declare bankruptcy.  Most lenders do the math on this, and realize that middle-class people are not about to go through bankruptcy, either out of shame, or because they don't want to lose other assets, or because they don't want to further damage their credit ratings.  So Joe Middle-Class will hang on for years, struggling to pay off debts like this, until they either succeed at it (as I did) or throw in the towel and go bankrupt - or die.

Sadly, most people fall into this trap. It's very similar to the trap of using a home refinance to pay off credit card debt. You clear off all your credit card debts and maybe other debts such as car loans and whatnot and feel that you're a financial superman.  But all that does is time-shift this debt to a 30-year mortgage secured by your home.  And the temptation, having a "zero" balance on your credit card again, is to go out and spend more.

Now, some might ask, is it possible to "steal the cheese" on these deals and roll over debt into one zero percent offer after another?  Yes, no, and maybe.  It is possible, but not probable, and eventually, debt has to be paid back.  These zero percent offers are not always available, and whether or not you get one depends on your credit rating and your debt load.  If you keep rolling over a zero percent offer and running up new debts, eventually your debt-to-income level will be such that they won't make you these offers or they won't let you have one, if you apply.   And then you are left standing there when the music stops, with a huge balance at 20% interest or more.

I have often made the analogy that a credit card is like a loaded handgun.  A handgun is a tool, like any other, and if handled carefully and safely, can be of use.  But carelessly handled, it will blow your head off - or that of a friend or family member.   A credit card is the same way - a loaded gun, cocked and aimed at your head.  One false move and its all over - yet the credit card companies want to paint that handgun in bright girly colors and tell you its "fun" and "kicky" because you'll get bonus points and airline miles for every bullet you use!   And sadly, a lot of people fall for this, and end up in a lot of credit card trouble - I know I did!

These 0% balance transfer offers are the same deal, only perhaps even more dangerous.  They can be a lifeline, or an anchor, and I've use them both ways.   Early on in my career, I took a minor credit card crises and turned it into a larger one with a balance transfer (back then, they were not nearly as generous!).   And, like an idiot, I "solved" that problem with a cash-out re-fi of my house.  Duh.    Later in life, I used a 12-month 0% transfer (with a 4% fee) to get out from under a 25% interest rate credit card.  That time around, I buckled down and paid off the balance over 12 months, and took stock of my life and decided that perpetual debt was no way to live. I also cut up the old credit card and closed that account, and went to a cash-basis in spending, until I got my house in order.

Sadly, most folks do as I did initially, and don't take these 0% offers as a sign their financial lives are in ruin, but rather as a sign of their financial acumen.  Hey, after all, the bank told them they were "smart" for taking such a "good offer" - right?

And we all know banks never lie to us, ever!