“I had plastic surgery last week. I cut up my credit cards.”
— Henry Youngman
“As human beings, we are endowed with freedom of choice, and we cannot shuffle off our responsibility upon the shoulders of God or nature. We must shoulder it ourselves. It is our responsibility.”
Should you keep transferring balances on your credit cards to try to avoid paying interest?
We’ll answer in a bit, but first, let me give you a little background.
I recently had a reader who wanted help in explaining why the following situation was bad:
[My friend] says he has a ‘great idea’ that if you get like 10 credit cards (or however many companies will let you) that you could move the money around each month and never have to pay interest on it, and you could pay it off a little at a time.
When I worked at Capital One, this is exactly what people would do – they’d get a 0% interest 18 month balance transfer offer, transfer the credit line of the largest Capital One card they had, get a check back for the credit, put the money in an ING account, wait 17 months, and pay off the card, getting the interest.
There were a couple of guys I knew who were making upwards of $10,000 a year in interest executing this plan.
If you’re savvy enough to manage a whole bunch of credit cards, have great rewards cards, and an already existing source of income, then, the next time there’s a wave of zero interest balance transfers like the go-go days of the early 2000s, then it can be a good way to make a little extra dosh.
Here’s why the plan worked for these people:
They had a budget already. These people knew where every dollar went and made enough income so that the extra $25,000 (or in some cases, $250,000) sitting in the savings account wasn’t a temptation to go on some mad weekend bender in Vegas.
They had systems in place to make extra sure they did not screw up. The catch with these zero interest balance transfers was that the minute you were late in repaying the card, you’d get an enormous retroactive interest charge tacked on. It was possible to add 20% to the balance you owed overnight if you weren’t careful. Most of the time, they paid off the cards a month early just to ensure no snafus.
They had great credit scores. Sure, the credit score would take a hit if you opened up 10 credit cards within two weeks and had 100% utilization on a $250,000 line of credit cards, but once they were paid off, the credit scores went right back up. If your credit score is less than about 760, you probably won’t ever see these offers.
They didn’t otherwise carry credit card balances. The key to success was that they otherwise had $0 credit card debt. Otherwise, they were going to fall into the next category of people whom I’ll discuss.
For people who had finally seen the light and were working to get rid of credit card debt, then the 0% interest balance transfers were also a pretty good deal. Why pay 10% interest on a card when you can pay 0% interest? If you’ve learned from your sins, then there’s no reason to continue to pay higher interest rates just to expiate your wrongdoing.
It was possible to run the final leg of the paying off credit card debt marathon on a zero interest balance transfer IFF (ooh! engineering!):
You were on pace to pay off the remaining balance in less time than the zero interest balance transfer offer was good for. For example, if the period was twelve months and you needed fifteen months to pay it off, then you weren’t a candidate because you’d get nailed with fees and interest on the stepped up rates.
You had the discipline of a Franciscan monk. This is an all-in strategy for paying off the last of your credit card debt. Once you’re committed, there is no going back, and you can’t slip and let your balances increase. Walk the narrow path, and it pays off. Stray, and you get decimated for your wrongdoing.
You’re very secure in your job. No chances of furlough for you. Your employer needs you there every day, or the company goes down the tubes. Why do I say this? Because you shouldn’t have any liquid assets sitting around! If you did, you’d have used them to pay off the dadgum debt in the first place! So, you’re relying on income to pay off your debt, and that income has to be absolutely, positively rock solid. If you get a pink slip in three months, you’d better be the world’s greatest hustler, because there’s a speeding bullet train coming right at you.
I’m a great believer in humanity, but I’m an even bigger believer in the djinn known as Monkey Brain. Faced with a huge pot of credit just sitting there, Monkey Brain is going to start drooling at the idea of having a 183” flat screen TV in the man cave.
I am assuming that the friend is running a balance and trying to avoid paying interest on the credit cards where he has a balance. There are two big reasons, and some lesser reasons, why this won’t work.
Interest accrues daily. This is the biggest killer to the plan. It’s not like the interest is calculated once a month so you could potentially go between 27 and 30 days without paying interest. Your friend is confusing grace period with daily balance method accounting. A grace period is the amount of time that you have to pay your credit card balance in full without accruing interest. It doesn’t work if you’re already carrying a balance. So, he can shuffle balances every day, and he’s just going to get sliced at each station along the way rather than one big whack of interest from one card.
Cash advance fees. Nowadays, he’s either going to have to write a convenience check from one credit card to pay for another credit card, or he’s going to have to do a balance transfer which comes with a 3% fee. These are not the heady days of the early 2000s when credit card companies were dying to get your balances into their books (for a credit card company, your debt is their asset) and wouldn’t charge you for the “convenience.” They realized that they weren’t getting the profit they were looking for from most of the people who qualified, and the bad credit risks just charged off and didn’t pay their cards anyway. So, now, they’re charging you to take that risk.
Additionally, this is, in reality, just delaying the inevitable – your friend is much better off spending his time and his efforts working to pay off the credit card debt as quickly as possible. Instead of seeking ways around the system, after all, nobody held a gun up to his head and made him run up credit card debt, he should be seeking ways to increase his income and decrease his expenses so that he can take out bigger chunks of his credit card balance.
It’s really behavior change that your friend needs to focus on. Trying to use mathematical wizardry (which doesn’t add up, in this case) to avoid paying off the credit card debt and changing the behaviors which caused him to get the debt in the first place is like punching yourself in the nose to make you forget about a broken foot. It doesn’t work. The pain in the broken foot is still there, and now you’re compounding the pain with the throbbing in the middle of your face.
Furthermore, using credit cards is a method of pain avoidance. When you pay in cash, you get a little bit of pain each time you use the cash. You’re firing up pain centers in the brain each time you have to plonk down a bill when you pay, and when you use a credit card, you’re apt to spend more money because there’s no mental punishment in doing so. You’re delaying the day of reckoning until the credit card bill comes, and, conveniently enough, you get anchored to the minimum payment rather than being forced to pay off the whole balance. Why do you think that credit card companies put a suggested minimum balance? It’s to leverage the anchoring bias so that you don’t pay off the entire balance, keeping you attached to their tether and racking up the interest. It’s much easier to let a future you deal with the day of reckoning than it is to deal with it in the present. We value current pleasure much more than future pleasure, a phenomenon called hyperbolic discounting, and, therefore, we’re quite amenable to the idea of all fun now, rack up the credit card bill, and deal with it later.
Remember, credit card companies are run by very smart people who think of most of the “smart” scenarios that people like your friend try to think of to work around the system and then create penalties for acting out those workarounds. There’s a reason why we spent ten minutes discussing responsible credit card usage in the rewards card video which I linked to above. Trying to trick the system rarely works, and almost never works when you’re already in their clutches and carrying a balance. The people who carry a balance and pay interest subsidize those who don’t.