credit card debt

Don’t Use a Balance Transfer to Pay Off a Personal Loan: Here’s Why

June 19, 2019 By Tamila McDonald Leave a Comment

If you are struggling to pay off your debt, landing a lower interest rate on what you owe can make a big difference. Usually, balance transfer rates on credit cards can look very attractive. Plus, they might even be lower than what you have on your current personal loan. However, using a balance transfer to pay off a personal loan isn’t typically a great idea. There are risks with that approach, and terms might not remain favorable over time. If you are wondering why you shouldn’t use a balance transfer to pay off a personal loan, here’s a look at why it’s a bad idea.

That Introductory Rate Won’t Last Forever

In the vast majority of cases, balance transfer introductory interest rates don’t last indefinitely. You may have access to the promotional rate for just six months, 12 months, or 18 months, which isn’t a lot of time.

After the introductory balance transfer rate expires, you are stuck with the credit cards regularly interest rate, which is commonly much higher than the rate you’d have on a personal loan. The average credit card interest rate falls near 17 percent.

If your personal loan interest rate is lower than your credit card interest rate after the promotional rate expires, you could find yourself paying more in interest as you pay down the balance or hit with a higher payment down the road. Most credit card payments are a percentage of your balance along with the interest charges. When the interest rate kicks in, your monthly payment will almost certainly go up, and this can have a major impact on your budget.

By sticking with your personal loan, you get a level of predictability. Personal loans tend to have fixed payments over the life of the loan, so you know exactly what you’ll need to pay each month until the debt is gone. Plus, personal loans are finite. You know how many payments are left and when the last one happens, giving you a precise date as to when you’ll clear the debt.

Balance Transfer Fees

Balance transfers come with fees, usually 3 to 5 percent of the amount of the balance you are transferring. The exact amount varies from one bank or credit union to the next.

This fee isn’t spread out over time. Instead, it is added to the balance you owe the moment the balance transfer goes through. As a result, you significantly increase your debt immediately, and that isn’t always a smart move.

If you stick with your personal loan, you aren’t accruing any more debt. Any fees associated with the loan are already part of your balance, barring particular (and somewhat rare) exceptions, such as early payoff penalties that a limited number of lenders levy.

Credit Score Impact

Paying off a personal loan with a balance transfer impacts your credit score. First, once the balance transfer fee goes onto your account, your debt load increases. This can negatively affect your credit score.

Second, when you pay off the personal loan, that account usually closes. As a result, the average age of your credit accounts shifts. If the balance transfer credit card is a new account, your average account age will likely go down, negatively impacting your credit score.

Finally, moving a personal loan debt to a credit card also hurts your debt-to-credit ratio. That ratio is a reflection of the amount you owe on your credit cards as compared to your credit limit. The higher the percentage of your available credit limit that you use, the worst that ratio is in the eyes of the credit bureaus. As a result, your credit score can take a pretty big tumble depending on the amount of debt you transfer.

While the exact impact on your credit score will depend on your unique situation, it is important to understand that it could be both noticeable and negative. If you may need to open another credit account in the relatively near future, doing a balance transfer to pay off your personal loan could make that harder, not easier.

Qualifying Isn’t Always Easy

If you don’t have a balance transfer credit card and were considering opening one to address your personal loan debt, it’s essential to understand that this isn’t a guaranteed option. Many balance transfer cards require borrowers to have at least “good” credit, usually with scores of at least 680 or 700. Some won’t approve anyone with less than “excellent” credit scores, typically around 750 or higher.

Even if you can get a balance transfer card with fair credit, the terms usually don’t work in your favor. The promotional interest rate may only be available for six months. Plus, the credit card’s regular interest rate after that will apply, and it’s commonly pretty high.

Additionally, opening a new card also impacts your credit score. You’ll have a “hard pull” on your credit report (too many of which can hurt your score), a lower average account age, an adjustment to your total available credit, and more shifts that all cause your credit score to change.

Risky Move

Ultimately, using a balance transfer to pay off your personal loan can be a very risky move. Unless you can guarantee that you can pay off the entire balance (including the balance transfer fee) before the promotional rate expires, it typically isn’t worth pursuing. And, even then, there is always an impact on your credit report, and your score might go down. If you can’t ride out a period with a lower score, then this approach isn’t right for you even if you can pay off the balance during the promotional period.

Instead, do your best to pay off your personal loan quickly. If you aren’t dealing with a potential early payoff penalty, you can save yourself a ton by making additional payments and working diligently to rid yourself of that debt while leaving it where it is, all while preserving your credit score.

Have you ever used a balance transfer to pay off a personal loan? Do you think it was a mistake? Share your thoughts in the comments below.

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How You Should Be Paying Off Your Loans

July 19, 2016 By Jennifer Clark 1 Comment

Sometimes, we need different loans for different occurrences in our life, such as a college education or a new home. So the reality of life in America is that juggling multiple loans at once is an unfortunate reality for many Americans. For those of you whose debts have metastasized like an alien in a science fiction movie, here is the skinny on how to get your obligations back under control.

Snowball vs. High Interest Method

There are basically two schools of thought when it comes to the strategy of paying off your debts: the snowball method and the high interest method. Both methods are similar but they have some important differences that need to be addressed if you are using either to pay off your debt.

Snowball Debt Reduction Method

The snowball method has been popularized by personal finance guru Dave Ramsey. The main idea is that that you arrange all your debts from largest to smallest and progressively attack each debt in turn. Once the smallest debt is paid off, you use the cash you would have spent on that debt to pay off the next highest debt, then the third, then the forth – etc. Pretty much the main idea is that your debt payoff progress starts to “snowball” – literally like a snowball rolling down a hill, your progress gets faster and faster.

Per Dave Ramsey, let us say you owe the following:

1. $400 medical bill ($50 payment)
2. $3,000 credit card debt ($112 payment)
3. $4,000 car loan ($100 payment)
4. $10,000 student loan ($134 payment)

With the debt snowball, list the debts in order of how much you owe (as above). Start by making the minimum payments on everything but the smallest debt. In this case, that’s the $400 medical bill. Assume you can come up with some additional side income. Possibly $400 a month – which you can get from any number of side jobs.

Since you are paying $450 a month on the medical bill (the $50 payment plus the $400 principle), that medical bill will last a month or so. Next, take that $450 and attack the credit card debt. You’ll be paying $562 on the credit card debt (the $450 plus the $112 minimum payment). In about five months, this debt should also be paid off.

Tackling the rest of the debts is simple, just add the amount from the medical bill and the credit card ($450 + $112) to the amount you are paying on the car loan ($100) this should be about $662 per month. This means it will take about six months to pay off the car loan. Once the car loan is paid off you’ll have about $796 to allocate to the student loan debt, which will be gone in about 12 and a half months.

So, with a little bit of the work and some sacrifice you will have paid off $17,400 dollars worth debt in just over 25 months. The main advantage of the debt snowball is that you get the psychological motivation by paying off the smaller debts first. The idea here is that debt reduction is a long term process and if you tackle the biggest debts first, you won’t stay motivated and won’t make progress.

The High Interest Method

The high interest debt reduction strategy is similar to the snowball method, but instead of targeting the lowest bills, the high interest method calls for targeting the highest interest debt first. Typically credit cards, store cards, payday loans or unsecured personal loans have higher interest rates than mortgages, car loans or medical bills. So in this case the high interest method would have you rank the debts like this:

1. $3,000 credit card debt ($112 payment)
2. $4,000 car loan ($100 payment)
3. $10,000 student loan ($134 payment)
4. $400 medical bill ($50 payment)

The credit cards and car loans are ranked first, as they are the highest interest debts.

To reduce your debts, pay the minimum on all your obligations except the highest interest debt. For that one, you need to put ALL your available cash to it. This means your emergency fund money, your rainy day cash – all your free cash, everything. It all needs to go towards the highest interest debt. Your savings will never earn more than a high interest credit card or unsecured personal loan. Do this every month. Once a debt account has been eliminated, remove it from the list and re-order until you are back in the black.

The high interest method has been shown mathematically to be the quickest way to reduce your debts. No other method will get you out of debt faster or save you as much money.

The high interest method only works if you include all your debts. So, consider all your complete picture.

Here are three additional factors which the high interest method mandates:

1. Manage your debts actively, so this means monitoring your debts to be sure your creditors don’t raise their rates. Credit card companies are notorious for arbitrarily raising rates. Some debts like medical bills can have late fees associated with them.
2. Factor in taxes. Mortgages and student loan debts are subsidized by the Federal government which means that their effective rates are lower than their nominal rates.
3. Actively manage when you pay your debts. In some cases if you pay your debt before it is due you can reduce your total interest paid.

One major problem with the high interest method is that it tends to ignore behavioral finance. People often aren’t motivated to keep paying off their debt if they don’t see an immediate return on their efforts. This is the advantage of Dave Ramsay’s snowball method.

Unfortunately not all debt is created equally, so what is the best approach to paying off your loans if you just have one or two separate debts?

Paying Off Your Credit Cards

Slow and steady is not the route you want to take with credit cards. The faster you can pay off your credit card balance, the better. The interest rates on this type of borrowed money is usually the highest possible (with the exception of usurious products like payday loans), and missing payments can be really harmful to your credit. In addition, may credit cards simply tack the interest owed onto the balance of what you owe. Ways you can defeat this is by paying more than the minimum balance and work on paying off the credit cards ones with higher interest rates first.

Avoid making only the minimum payments. If you only continue to pay off the minimum balance, you set yourself up to pay more in interest, which can add up to more than what you initially borrowed. Also, avoid using credit cards to pay off other debts if you’re already have several other looming financial obligations, particularly with higher interest rates. Credit card companies are getting wise to balance transfer schemes and are less likely to give you points these days for these sorts of transactions.

Repaying Car Loans

A car loan can be paid similarly to a mortgage, but with shorter repayment terms, paying off this loan faster makes sense. Making bi-monthly payments will cause you to obviously pay more toward your car loan each year, even if you only commit an extra $50 per month. So consider these types of accelerated payment schemes.

By paying off the car loan faster, you do reduce your interest as well. Be sure to talk to your lender first, as sometimes it is frowned upon to pay off this type of loan early. In general car loans aren’t tax deductable and they are secured against depreciating assets so you don’t have much to show for this kind of debt at the end of the day.

Repaying Student Loans

The average time it takes to pay off student debt for a bachelor’s degree is roughly 21 years, according to research, and even longer for a master’s degree. But, in addition to paying your monthly minimum amount due, paying extra toward your loan each month will help to reduce the overall balance. Dedicate a specific amount to regularly pay on top of your minimum to maintain consistency. Anywhere from $50 to $100 is great, but if you can do more, you should. Talk to the company handling your loan to see how extra payments should be made. In some cases, paying it at the same time of your minimum requirement causes it to only go toward interest instead of your overall balance.

A big mistake you’ll want to avoid when repaying student loans, though, is to be cautious of consolidating federal loans through private lenders. In fact, before you consolidate at all, be sure to really look at the numbers. If you have really high interest rates with specific types of student loans, it may be a good route to take; however, consolidating is not necessarily a guarantee of better rates or loan terms. Look at all the details before jumping the gun.

Paying Your Mortgage

How you work toward paying off your mortgage depends on whether or not you want to repay it faster than the typical 30-year period. You effectively have two choices, you can either carry the mortgage for the life of the note or you can pay it off early. Carrying the mortgage in the allotted agreed time has its own benefits, such as tax deductions and expense predictability. Also, a key factor in thinking about paying off your mortgage early is whether you have a better use for the money. For example you could use the money would you would otherwise put towards the mortgage for investments like retirement or college savings for your kids.

Paying extra should only be done if you can feasibly do it financially. If money seems like it will be tight after paying extra, don’t do it or find a way to make it work like through a supplement income. This is because mortgage interest is tax deductible, which means its generally “cheaper” money than credit card debt.

Mortgages are like any form of debt. One of the main keys to remember with paying off loans is ensuring you’re making your payments on time. Not doing so can result in penalties and dragging out the repayments longer. Remember to research the loans, repayment methods, and be wary of quick repayment schemes, as some of these have substantial risk. Check out the mortgage professor for more on this.

Does Where You Live Impact Your Credit Score?

February 16, 2016 By Amanda Blankenship 2 Comments

Your credit score is more important than you know. People are constantly looking at it, making decisions about your ability to handle finances. That number can impact all different parts of your life and, while it is just a number, it can prevent you from doing a lot of things. Missing payment on a bill or ignoring creditors can be a big mistake. However, according to a new survey, where you live may have an impact on how you handle debt collectors and how much of your debt is sent to collections too.

Does it really matter where you live when it comes to finance? Well, maybe. According to a new survey released by Credit Karma, there may be some kind of connection between the two. People ages 18 to 24 Taking a look at the 100 largest cities in the United States, the company was able to determine where this age group seemingly has the most debt in collections.

Utility bills, credit card payments and other debts can be easily thrown away. Seeing a debt collector on your caller ID can make it pretty easy to dodge them too. However, throwing it away and ignoring it will not make your debt disappear. Eventually, your debt will be sent along to a collections agency which leaves a mark on your credit report for more than seven years. Young people are especially vulnerable to this.

According to recent studies, only about 28 percent of people between 18 and 24 received any kind of financial education prior to college. Forty-four percent of that same age group has said that they’ve already had accounts sent to collections. But, it seems that they are way too young for that to have happened, right? Well, no. Most 24-year-old have at least one item in collections right now.

This type of financial hardship seems to be running rampant in certain parts of the country. Certain cities seemingly have more young people in debt than others. Is it because they have more young people in the area or because that area simply doesn’t provide enough financial education to these young folks to make a difference? It is up for discretion, however, it is most likely the latter rather than the former sending these young men and women into debt.

The following 10 cities have the most people ages 18-24 who have items that have been sent to collections (city and average number of items in collections – rounded the nearest tenth):

Milwaukee, WI: 3.2
Louisville, KY: 2.3
Indianapolis, IN: 2.3
Charlotte, NC: 2.2
Greensboro, NC: 2.2
St. Petersburg, FL: 1.2
Las Vegas, NV: 2.0
St. Louis, MO: 2.0
Reno, NV: 2.0
Birmingham, AL: 1.9

It seems that throughout the entire country (and maybe especially in North Carolina and Nevada) people are having difficulty managing their finances before they even hit the age of 30. Though a bit disheartening, there may be something to take away from this (and no, it’s not to avoid these cities). There needs to be a movement, nationwide, to better financial education for people prior to heading off to college. It could make all the difference in these people’s lives.

Photo: Flickr: Simon Cunningham

How to Become Debt Free

January 7, 2016 By Amanda Blankenship 1 Comment

Becoming debt free is a goal many people have, however, it often seems just out of reach. To others, it seems like it is just around the corner or further down the road. Either way, becoming debt free is certainly a primary goal for many people. Whether it is credit card debt, medical bills, a car payment or a mortgage, debt is weighing a lot of people down, and they are ready to get rid of it. A debt-free lifestyle seems like a fantasy, however, it is a possibility if you take a few steps in the right direction. Let’s take a look at a few simple steps you can take towards becoming totally debt free.

Evaluate Your Debt

Many people refer to debt using two elementary words: good and bad. In reality, there is no “good” debt, however, it makes it much less scary to refer to it that way. Oftentimes, “good” debt fulfills a need while “bad” debt fulfills wants. “Bad” debt refers to high-interest rates on your debt. Oftentimes, “bad” debt refers to credit cards, which are known for their brutal interest rates. “Good” debt refers to things like student loans, mortgages and even a car loan. Each of these things fulfills a need of the person taking the debt on. Usually, the “good” debt someone has doesn’t have to be rushed to be paid off in advance.

Either way, whether most of your debt is good or bad, you have to determine how much of it you have to tackle to massive task of paying it off. You do this by determine your debt-to-income ratio. You take your monthly debts payments and divide them by your monthly income to get this number. This does not include any mortgage payments. Prior to adding in your mortgage, your debt-to-income ratio should be around 20 percent. After you add in your mortgage, it should sit at 43 percent.

Repayment

Once you’ve determined your debt-to-income ratio, figure out how (and when) you will pay the debt back. The approach you take should be based on your debt-to-income ratio. If your ratio is higher than 20 percent, you may want to seek some debt counseling and advice on how to approach paying your debts off.

If your debt-to-income ratio is lower than 20 percent and more manageable, focus on the high-interest accounts first. Obviously, still make your monthly payments for the other accounts, but focus most of your efforts on paying the high-interest accounts down first. Once you’ve paid those off, focus on the lower interest accounts and get those paid off.

You have to have organization when tackling the task of repayment. You have to have a budget that includes the amounts you will pay towards your debts as well as your regular monthly bills. Set goals for your debt repayment, and make sure you stick to them. Without organization, the plan may not be successful.

New Habits

Once you’ve paid your debts off, you will want to form some new habits. Obviously, you got into debt somehow, and you do not want to have to go through repaying debt again. Being “debt free” is desired as a long-term label, not a temporary one. The lifestyle you lead to pay off your debt should not be a “quick fix.” They should be long-term habits that you will follow for, well, the rest of your life.

When you get your debt paid off, you should be proud of yourself! It takes a lot of hard work and determination. You can go on to live a debt-free life if you simply take responsibility for your debt and take charge of repaying it.

Americans Love Debt Again: Consumer Credit Card Spending Surges by $8.8 Billion

June 7, 2014 By Jeffrey Strain 2 Comments

consumer revolving and non-revolving debt surges

Consumers seem to have forgotten their lesson that debt is not their friend. In what might be a positive sign for the economy that consumer spending is increasing, the April data from the Federal Reserve isn’t good news for those who hoped Americans would learn to be more responsible with their personal finances.

The Federal Reserve reported Friday the total amount of consumer credit had increased $26.85 billion to a total of $3.18 trillion, a rate much higher than most analysts had predicted. It was also a large increase from the $19.5 billion increase recorded in March. Those numbers indicate consumer debt is now increasing at a 10.2% annual rate. This is the fastest growth in consumer debt since July 2011. Most of this came from non-revolving credit, the type which includes auto and student loans, which increased by $18 billion in April.

The numbers were even worse when it came to credit card debt. The Federal Reserve reported revolving credit, the type which measures the use of credit cards by consumers, increased by nearly $9 billion ($8.8 billion). This means that credit card debt is now running at a 12.3% annual rate gain, a number not seen since just after the September 11, 2001 terrorist attacks when consumers were being urged to spend more in an attempt to help improve the economy.

The fundamental personal finance principle for credit card use is to never actually borrow money on the cards. That is, any purchases placed on a credit card should be paid off in full when the bill comes so that you don’t end up paying the double digit interest rates which come with credit card loans. While consumers racking up credit card debt might help the economy short-term, it hurts it long-term, as those consumers must pay money as interest to credit card companies rather than spending the money to buy other goods.

For those who do have any type of consumer credit card debt, the best course of action they can take is to begin to pay it off as soon as possible. One of the best ways to do this is to set up a debt snowball to begin paying it off. In addition, it’s important to put in place a strategy to build an emergency fund so they can avoid further credit card debt in the future.

The increased willingness of consumers to borrow on credit cards shows many still fail to understand the high cost of making purchases with borrowed money. Interest rates can significantly increase the cost of any product or service which is purchased on a credit card, and not paid off in full at the end of the month. Credit card debt also makes it difficult for most people to reach their long-term financial goals as they are forced to pay off the debt rather than invest the money toward their future financial goals.

Until becoming debt free becomes a priority for Americans, rather than buying things they don’t currently have the money for, there will continue to be a personal finance crisis in this country. As the latest data shows, it doesn’t seem becoming debt free is a priority for many.

(Photo courtesy of Sean MacEntee)

Consumer Borrowing Increase Verifies Consumers Still Stink at Finances

May 7, 2014 By Jeffrey Strain 3 Comments

If there was any ray of hope that US consumers could learn the lesson that consumer debt was not their friend, and try to part ways with it, the latest numbers suggest that consumers have no intention of breaking up their consumer borrowing romance. Outstanding consumer credit soared in March to the largest increase it’s seen in a year, with consumers going into debt for student loans and borrowing to buy new vehicles. Consumer borrowing now stands at $3.14 trillion, an increase of $17.53 billion, which is the biggest gain since February 2013.

There was great news last month when consumer revolving credit, which is mostly credit card debt, decreased by some $2.73 billion in February. A continued decrease in this number could have signaled that consumers were finally trying to break their terrible credit card debt habit. Instead, consumers decided to take their credit cards out onto the dance floor again this month by adding $1.13 billion to their consumer revolving debt.

While these figures might be good news for the overall economy, they are terrible news for individual consumers and their personal finance. One of the first rules of personal finance is to live within your means by spending less than you earn. Consumers putting more revolving debt on their credit cards shows that many still haven’t learned these lessons.

For those that currently do have credit cards that they aren’t paying off in full each month, doing so as quickly as possible should be their number one priority. The first step is to realize that consumer debt is bad for your personal finances. The next step is to put together a plan to eliminate the debt that you have. There are a number of snowball methods that can help anyone pay down their credit cards and other personal debts, plus a couple of easy ways to build an emergency fund so that there is no need to put debt on the credit cards or borrow in other ways in the future.

Until consumers realize that credit cards aren’t free money, and that they cost a small fortune in interest payments when not paid off in full each month, they are going to continue to struggle to meet their financial goals. The goal of almost every consumer should be to be debt free as quickly as possible. These latest numbers from the Federal Reserve show that there are still far too many Americans that suck at personal finances.

(Photo courtesy of Jason Rogers)