Wednesday, November 18, 2009

Credit Cards with 0% Balance Transfer for Life

We’re all familiar with the idea of introductory rates. They are a good price that starts low to draw you in and jumps up later. This is common with internet providers, cable television, and credit card balance transfers. But, what if the fantastic deal stays in place indefinitely? There has to be a catch, right?

MoneyNing wrote about a variant of the 0% credit card balance transfer that I hadn’t seen before. Usually, the deal is that the debt transferred to the new card is charged no interest for a few months, and then the interest rate shoots way up.

There are two main ways people get caught with this deal. The first is that they are unable to pay the balance off before the interest rate shoots up and they have to pay excessive interest. The second catch is that if they use the card for new purchases, payments go toward the 0% balance and the new purchases start collecting high interest right away (although there is pending legislation to force credit card companies to apply payments more favourably for cardholders).

With a 0% for life balance transfer, we could beat the credit card company by just never using the card for new purchases. But that’s where the catch comes in. When credit card issuers offer 0% for life transfers, they require cardholders to make at least two purchases per month or else the interest rate would shoot up.

This could still be a good deal if the cardholder pays off the balance fast enough that the new purchases don’t accrue high interest for too long. To test this, I looked at the following scenario. Andy owes $5000 on a credit card. He is considering one of two approaches:

1. Use the 0% for life balance transfer. Andy will make two $20 purchases each month and make a $150 credit card payment each month until the card is fully paid off. We’ll assume that the interest rate on new purchases is 1.5% per month. (This is what the credit card companies would call 18% per year, but is actually 19.56% per year.)

2. Take out a line of credit for $5000. With the $150 available each month, Andy will make the two $20 purchases with cash and use the remaining $110 as a payment on the line of credit.

The question is what interest rate on the line of credit would cause the two debts to be fully paid off in the same number of months? It turns out that the credit card balance would be wiped out after 4.5 years. The equivalent interest rate on the line of credit that gets paid off after the same length of time is 5.7%. So, if the best rate Andy can get on a line of credit is more than 5.7%, he’s better off with the 0% transfer deal.

However, this analysis is very sensitive to the initial assumptions. What if Andy spends $100 per month and makes $200 payments? Then the credit card debt takes 5.5 years to pay off, and the equivalent line of credit interest rate is 10.6%. In this case, Andy is very likely better off with the line of credit.

Almost every special credit card offer is a potential trap to get you paying high interest on debt. Be wary.

6 comments:

  1. I recall reading about a scheme on another blog whereby a savvy borrower does a balance transfer to a 0% card for the duration of the promotional period, then moves the balance to a fresh 0% card, rinses, and repeats, etc.

    You detail the potential pitfall in your post of not using the new card for fresh purchases.

    The other problems would be that 1) you would not be able to find a replacement 0% offer at some point, and 2) Opening many credit cards could affect one's credit report/score.

    As long as someone keeps enough money on hand to pay off the balance in full if required and also doesn't need to borrow money again in the future (owns own house and is financially independent), it's fairly low risk.

    I've always wondered if you can transfer a balance from another card if you don't have a balance on the card to be transfered from. I never carry a balance, so have never taken advantage of a transfer offer.

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  2. Gene: I think you're talking about this blog entry, where I describe Madison's elaborate credit card arbitrage scheme. I haven't seen her post anything on this lately. Either she isn't running the scheme any more or she doesn't think it will interest her readers. You may be right about it getting difficult to find 0% balance transfer offers with the same nice terms.

    I don't carry balances either. I don't know if you can "transfer" a nonexistent balance, but it wouldn't be too hard to simulate. I wouldn't recommend this, but one could get a card, max it out with cash withdrawals, pay the interest charges for the first month, and then transfer the balance elsewhere.

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  3. How low a purchase can you make to count on the credit card? If you made two $5 Gas Purchases, could you get away with that? What if you bought two Candy Bars?

    How about not rolling up a huge debt on your credit card? Just figured I'd ask

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  4. Big Cajun Man: I read about one guy who says he makes two 1-cent purchases with PayPal automatically each month. If that works, then it would be a great solution. As you say, an even better solution is to not run up consumer debt in the first place.

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  5. There's a third catch, which is that if the card owner is late on a single payment, the interest rate shoots up to the default rate.

    In my case, I transferred almost $15,000 of higher interest debt to a card with a promotional rate of 1.99% for life. I make the minimum payment TWICE per month, just to be sure that I don't miss a payment, which would result in a new interest rate of 19.99% (i.e. more than 10x the promotional rate). However, as long as I keep up the payments, this approach is saving me hundreds of dollars in interest every month, while I wipe out the last vestiges of higher=interest debt.

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  6. MarliO: You're right that failure to pay on time even once is another way that credit card companies can catch people and jack up their interest rates. I hope your balance transfer works out for you. It sounds like you're being appropriately cautious. I hadn't heard of making the minimum payment twice, but it's a good idea. I've heard of people having trouble because a payment gets delayed or lost. You'd have to be extremely unlucky to lose out this way.

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