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Some things sound great on paper and end up being just as great in real life, like bacon-wrapped shrimp and blankets with sleeves.
Other things, however, may sound great in theory, but simply don’t work the way you thought they would, like Crystal Pepsi or a theme park filled with real dinosaurs.
Debt consolidation sounds like a sure winner on paper, but every variety of consolidation carries certain risks, and balance transfers, in many ways, are the Jurassic Park of financial solutions – if everything goes just right, they can be a great way to save money and pay down debt quickly.
But how often does everything go just right?
What is a balance transfer?
Balance transfers are simply the act of moving a debt (usually unsecured credit card debt) from one account to another, most often with a 0% interest rate as the primary enticement. They’re a popular form of debt consolidation, because consumers benefit from the reduced APR (annual percentage rate), saving money on interest charges and paying down debt faster as a result.
Sounds good, right?
What could go wrong?
Cue the Velociraptors!
First, most credit card companies now charge a transfer fee, generally in the vicinity of 3% to 5% of the total balance. Try to consider how quickly you plan on paying off the debt in order to make sure that the fee you’re paying is less than the amount of interest you’ll end up saving.
Second, you have to bear in mind that the 0% rate is generally for a limited period of time (usually between 3 and 18 months). Are you going to have the entire debt paid off before the rate expires? If not, prepare for your APR to go up, potentially all the way to the maximum allowed.
Also, some 0% promotions are actually deferred interest promotions, which means that if you don’t have the full balance paid off at the end of the set term, you’ll be on the hook for all of the interest that accrued during the life of the promotion (which could be substantial).
Another thing to keep in mind – that rate is almost always contingent on making on-time payments every single month. If you miss one payment you’ll find yourself back at that high interest rate, not saving any money at all!
The state of your rate
A mistake consumers often make with these new credit cards is using them to make new purchases.
Consumers will often roll all of their pre-existing credit card debt into a new card, meaning the old accounts are closed and therefore no longer available to use. This means that if they need to use credit, they go straight to the newly open account. The problem is that the 0% APR usually only applies to the balance transfer – new purchases are subject to interest charges.
On top of that, credit card companies are free to apply your monthly minimum payment towards whichever balance they choose – and they almost always choose the portion of the balance with 0% interest. All of which means that your new purchases are accruing interest every month, while the balance on those purchases isn’t going down at all!
(It’s important to note, thanks to the CARD Act of 2009, that credit card companies are now required to put the portion of your payment that's beyond the minimum amount due toward the balance with the highest APR.)
How your credit score factors in
One of the factors (and there are many) of calculating your credit score is the length of time your accounts have been open – the older your accounts, the better that is for your score.
When you roll all of your balances into one new card, the old accounts are closed, and instead of having multiple old accounts, you now have one brand new account, which could have an enormous impact on your credit score.
What are your alternatives?
If you’re looking for a reduced interest rate and the ease of a single consolidated payment, debt management might be a better option for you.
For consumers who qualify for debt repayment through a Debt Management Plan, the lower interest rate is generally fixed for the life of the debt and in most cases won’t default for a single missed payment.
Also, Debt Management Plans are designed to fit within your budget and have you debt-free in 4 to 5 years!
Consult with one of MMI’s certified credit counselors today to see if a Debt Management Plan is right for you!
After reading through the article, I feel I should add a couple of thoughts that aren't quite covered here... First off, If you are struggling with debt, stop what you are doing, playing the debt shuffle game won't help, you have bigger problems that balance transfer isn't going to fix. Balance transfer is a game that only works for people who have no financial crisis in their life. Why you ask? Read on.There is the fact that if you pay it all off in the allotted time before the intro rate ends then you don't pay any interest, this is a good thing. Then there is the fact that if you don't pay it off before the intro rate ends you are stuck paying a higher rate. For some people, this may still seem like a great deal because they may have transferred 2000 from a card charging 26% interest onto a card that will only ever get to 19% after the intro rate ends. One problem that can occur that isn't covered here (but close) is late payments. A late payment will cause problems in not only a late fee, but also in something that is in the super fine, don't look here, print. It is called the general default clause and quite often it will read that if you are late on ANY of your credit card payments that this creditor can raise your rates and BOOM... you are now stuck for their DEFAULT interest rate.But this isn't even the worst of it... The really big issue that no one seems to ever see is that the card that has the balance of 2000 is very likely only carrying about 1500 in actual purchases and the rest are interest, fees and for some unfortunate people, penalties and default interest rates. These people, the ones that are in such deep trouble that they are in default already or it is just a matter of time, should NEVER do balance transfers.NOT. EVER. FOR. ANY. REASON.Why? Because once the original card goes into default, the original creditor is very likely going to be willing to make a deal on the total amount to recover the principal. This is the basis for debt settlement. The issue is, if you transfer a balance, the money that can be negotiated (fees, interest, penalties) is paid along with the principal debt and is now "real" debt instead of something else.What this means for the people who can't pay the balance transfer off quickly, is that they just threw away what may have been their best chance to save a ton of cash by borrowing MORE money to throw at it.People need to get past this idea that a SCORE is worth something. I haven't had a decent credit score in years and I get along better than most people. For that matter, I actually OWN the things I have rather than OWE to have things and I couldn't be happier. For those people who are truly in need of help, check out sources like Dave Ramsey, Weathering Debt, and the FTC, they all provide great information and Weathering Debt is the most comprehensive DIY guide I have ever seen on the matter of debt resolution, no fluff, just straight information, sample letters and instructions on how to use the laws to your benefit.Most of all, don't take my word for it, just read everything you can get your hands on... the education is the most important part. Stop listening to the people trying to SELL YOU SOMETHING.
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