Credit Card Debt Consolidation
If you have a number of credit cards on the go, it can be difficult to keep on top of them. You spend a little on one card, and a little on another, and before you know it, you have run up a balance on all of your cards that you don’t know how you will pay off. So, what do you do now?
While it may be tempting to simply pay the minimum on each card and leave it at that, that’s not the best solution in the long run. Why? Paying the minimum on your credit card is a one-way ticket to long term debt. Each month, your balance will continue to accrue interest, as you pay off only a small amount. Depending on the size of your balance, you could stay in debt for years, if not decades, while paying out a small fortune in interest.
Frank has run up a debt of $10,000 on his credit card. With an interest rate of 20% p.a., interest is really starting to stack up. However, Frank thinks that if he pays the minimum repayment on his card, he will clear his debt eventually.
While Frank will indeed clear his debt eventually, it will take him 61 years and 3 months if he only pays the minimum each month (and that’s without any new spending on the card). Over that time, he will pay back the $10,000 he owes on the card, plus a whopping $42,073 in interest.
Alternatively, Frank could opt for a balance transfer to save on interest as he pays down his debt. By choosing a 0% p.a. balance transfer offer offered over 22 months, Frank could clear his transferred balance within that time by paying off $455 per month.
Doing this, Frank would save $2,923 in interest (compared to if he were to let his balance carry over during that same 22 month period).
So then, is a balance transfer a good alternative?
What is a balance transfer?
A balance transfer offer is a type of introductory offer provided to new cardholders looking to pay down debt on their existing credit cards. How does it work? When you apply for a card with a balance transfer offer, you advise your new card provider of the balance you want to transfer. Once your application has been approved, the funds from your old card accounts will be transferred onto your new card.
Over an introductory period, your transferred balance will accrue interest at the card’s low balance transfer rate. Now, as you are paying less in interest on your balance, you can work on paying off more of what you owe, to clear your debt faster. At the end of the introductory period, if any of the transferred balance remains unpaid, it will revert to the card’s purchase rate or cash advance rate, as determined by the card provider.
Why choose a balance transfer?
You want to pay less in interest
One of the main reasons you would opt for a balance transfer to consolidate your debt is to pay less in interest. The balance on your current card could be accruing interest at a rate of 20% p.a. or higher. Over time, those interest charges will really stack up, making it harder to pay off what you owe. By choosing a balance transfer offer, you could consolidate all your debts attracting a high rate of interest into one balance with a rate as low as 0%, potentially saving you hundreds, if not thousands in interest.
You want to pay down your debt faster
You want to get out of debt fast? A balance transfer offer could make that happen. While you will need to put in the effort to clear your consolidated debt within the introductory period, this type of offer could give you the motivation you need to pay it down faster.
You want one balance, not multiple balances
Juggling multiple debts can be stressful. Keeping on top of multiple balances, each with a different interest rate and repayment date is not easy. By opting for a balance transfer offer, you could consolidate all your debts onto one card – with just one repayment date and one interest rate. And, if you choose the right offer, that rate should be significantly lower than the rates on your current cards, over the introductory period at least.
You want a new card
Whether your needs have changed since you first applied for your current cards – or they’ve simply never been right for you – a balance transfer could allow you to switch the balance from all your other cards onto a card that better suits your needs. And all the while, you enjoy a much lower rate of interest on your transferred balance over the introductory period. Win win.
TIP: If you are unable to cope and you don’t know how you’ll get out of the hole you’re in, getting some professional advice is a good place to start. The National Debt Helpline is a not-for-profit service that helps Aussies tackle their debt problems, with professional financial counsellors that offer a free, independent and confidential service.
Making Your Balance Transfer Work
Okay, so you’ve decided a balance transfer is your debt consolidation route of choice. How do you make it work for you?
Step 1. Choose The Right Offer: Compare balance transfer offers to find the right one for you. Think about what debts you want to transfer, how much that balance will come to, and how long you will need to pay if off. Try to match those needs with a balance transfer offer that will give you the lowest balance transfer rate and a sufficient intro period to get your debt cleared.
Step 2. Choose The Right Card: If your sole goal is to pay down your debt, try to focus on the offer rather than the card. While you will need to look at factors such as the card’s annual fee and revert rate, other features such as rewards should really be ignored for now. By choosing a card that encourages spending (such as rewards cards and cards with bonus points offers), you may find it difficult to focus on what’s important – clearing your transferred balance.
Step 3. Create A Repayment Plan: Once you’ve been approved and your balance has been transferred, you will know exactly how much you need to pay off – and how long you’ve got to do that. Work out how much you will need to pay off each month to clear your balance within the introductory period, and set up automatic payments to make it happen.
Step 4. Close The Old Account: You now have a bunch of credit cards, each with a balance at zero. Look tempting? To avoid the temptation to spend, it’s a good idea to close all those old card accounts once their balances have been cleared.
What To Avoid
Dealt with correctly, balance transfer offers have the potential to save you serious money as you consolidate to get out of debt faster. However, they also have the potential to lead you further into trouble if you don’t follow the rules. Here are some common mistakes to avoid if you want to make your balance transfer work for you.
Spending On The New Card
New card, time to spend? Nope. Unless you have the funds to pay off your new spending and your transferred balance, it’s best to hold off on using your card until your transferred balance has been paid off. Aside from adding to your debt and making it more difficult to pay it off, new spending also starts accruing interest from the day it’s made.
Spending On The Old Card
After transferring the balance from your old cards, it can be tempting to start spending on them. Again, this is a bad idea as you are adding to the debt that are working on paying off. While keeping older accounts open can be good for your credit score, consider closing the accounts you no longer need to reduce the temptation to spend.
Leaving Repayment To The Last Minute
You have 12 months to pay off your transferred balance. That’s heaps of time, right? No, it’s not. That introductory period, no matter how long it may seem when it starts, will fly by. If you put off making your repayments, thinking you have lots of time left, you are likely to find yourself at the end of the intro period with a big chunk of that transferred balance still left to repay. And then it will revert to the card’s purchase rate or cash advance rate, leaving you in much the same position as you were before you applied for the balance transfer.
What if you decide a balance transfer isn’t for you? Balance transfers aren’t for everyone – but there are other options out there. Some alternatives to consider could include the following.
Personal Loans: A personal loan could be a good option if you have a number of different types of debt that you want to roll into one. Taken out over one to seven years, a personal loan could also work well if you need more time to pay off your debt than a balance transfer can provide. It’s worth bearing in mind that a longer timeframe may mean you pay more in interest, so do your sums to work out whether it’s the right option for you. Establishment fees and ongoing monthly fees should also be taken into account.
Home Loan Refinance: If you are a homeowner, you may consider rolling your debts into your home loan in a refinance deal. While this will take the pressure off, remember that paying off your short term debts over a much longer period will likely mean it costs you more in interest. You will also need to deal with a fair amount of paperwork to apply for the new loan, while also meeting your lender’s credit requirements for the higher amount you’re looking to borrow.