Understanding the Mathematics of Personal Finance
TRANSFERS
Transfers are “deals” offered by a credit card company to lure you away from another credit card company. Each offered deal is unique, so you might have to do a little work to evaluate, compare, and contrast them.
Let me create a fictional transfer deal: If you transfer your balance from credit card company X to credit card company Y, company Y will allow you to maintain that balance, and possibly some level of new purchases, for 12 months (from the transfer date) at 0% interest. This can be a very good offer. Remember that there is always a time value of money, so an offer to assume a debt of yours (your outstanding balance at company X) for a year with no interest is in effect paying you to switch credit card companies.
Just how much this deal is worth depends on what your balance with company X is, how much interest you’re paying company X, and what your intentions and abilities to pay off this debt are.
The spreadsheet Ch6CardBalanceTransfer. xls on my website lets you analyze various scenarios. This spreadsheet compares two alternatives, that is, keeping your original card with taking a transfer offer. The spreadsheet assumes that you have the savings balance from which to make payments. It then compares your net worth at the end of some number of payment periods for the two alternatives. In other words, what I’m doing here is calculating the present value of the two alternatives.
In creating this spreadsheet, I assumed that you will make regular payments on time. Missing or late payments invoke penalty fees as well as extra interest, and unless you know your upcoming late/missing payment schedule, there’s no way to calculate any of this beforehand. The spreadsheet assumes that you have an amount twice your card balance (an arbitrary choice) in a bank account on day 1 and that all payments are made out of this bank account.
Your net worth in this example is the difference between your savings account balance and your credit card balance.
|
Keep original credit card |
Switch cards |
||
|
Pmt Bank Card X |
Net |
Bank Card Y |
Net |
|
Nr balance balance |
worth |
balance balance |
worth |
|
($) ($) |
($) |
($) ($) |
($) |
|
0 |
24,000 |
12,000 |
12,000 |
24,000 |
12,000 |
12,000 |
||
|
Nr Pmts |
12 |
1 |
23,880 |
11,980 |
11,900 |
23,880 |
11,860 |
12,020 |
|
Pmt |
$200 |
2 |
23,760 |
11,960 |
11,800 |
23,760 |
11,719 |
12,040 |
|
Balance |
$12,000 |
3 |
23,639 |
11,939 |
11,700 |
23,639 |
11,578 |
12,061 |
|
Rate of old card |
18.00% |
4 |
23,518 |
11,918 |
11,599 |
23,518 |
11,436 |
12,082 |
|
Rate of new card |
6.00% |
5 |
23,396 |
11,897 |
11,499 |
23,396 |
11,293 |
12,103 |
|
Rate of savings |
4.00% |
6 |
23,274 |
11,875 |
11,399 |
23,274 |
11,149 |
12,125 |
|
7 |
23,152 |
11,854 |
11,298 |
23,152 |
11,005 |
12,146 |
||
|
8 |
23,029 |
11,831 |
11,197 |
23,029 |
10,860 |
12,169 |
||
|
9 |
22,905 |
11,809 |
11,097 |
22,905 |
10,715 |
12,191 |
||
|
10 |
22,782 |
11,786 |
10,996 |
22,782 |
10,568 |
12,214 |
||
|
11 |
22,658 |
11,763 |
10,895 |
22,658 |
10,421 |
12,237 |
||
|
12 |
22,533 |
11,739 |
10,794 |
22,533 |
10,273 |
12,260 |
Consider the following example: You are offered a 1-year (12-month) transfer deal that lets you move your existing balance of $12,000 from an existing 18% APR account (Card X) to a 6% APR account (Card Y). Your savings are earning 4%.[15] The monthly payment you plan to make is $250.
Table 6.1 shows this spreadsheet. Your net worth at the end of the year jumps from $10,835 to $12,266 if you switch cards. Since the purpose of this spreadsheet is to make comparisons rather than to calculate a detailed balance, I з m showing amounts only to the nearest dollar.
If you get an offer of 0% interest for switching, your net worth jumps to $12,922 at the end of the year (enter 0% in the rate new card cell). You can change any or all of the variables to the left of the green line arbitrarily and reversibly, evaluating every transfer offer you receive.
A few words to the wise about transfers. First of all, if you take one of these deals and then spend the money that would have gone for payments on something else, you come out in a mess at the end of the year. If this money is needed for a family health or other emergency, well, you just do it—but otherwise this is a poor strategy.
Next, why on earth would a credit card company want to give you an interest - free or very low-rate loan for a year (or 9 months, or for however long it offers the deal)? Clearly, in the grand scheme of things, it must be making more money by offering these deals than by not offering them. There are four answers to this puzzle:
1. Card Y has lured you away from card X. Card Y has gained a customer and card X has lost a customer. Remember that credit card companies also make money from the vendors when you charge a purchase, and you will be making more purchases (and possibly paying more interest) in the future.
2. Many people lose track of the upcoming due date when the deal ends. If the balance, or the agreed upon part of the balance, is not paid by this upcoming due date, various fees and/or back interest payments will be charged.
3. Many people divert payment money to buy other stuff. Often, they’ll spend even more than the payment money they ’ ve diverted. This means that at the end of the year, they’ve not only spent all the money that would have gone to the original balance, but they’ve accrued even more new credit card debt.
4. Read your credit card paperwork carefully. Certain balance transfer offers may take away the grace period on purchases. I’ll discuss more about the importance of the grace period below, but in a nutshell, this is saying that in some cases, even if you pay for new purchases the day the statement arrives in your mailbox, you’ll still be paying interest on these new purchases to the credit card company.[16]
