In this edition of "Bank of Dad" our columnist walks a reader through the best ways to pay off a mountain of debt split over numerous credit cards.
My wife and I have $17,893 in credit card debt spread across three credit cards. Is it the right move to consolidate the debt into one account to avoid the interest, or should I keep them all and pay them off? Or is there another option I’m not considering? Will this fuck our credit score? — Sean, 37, Louisville.
Transferring your balances to a new card will likely put a dent in your credit score – at least in the short run – although that might be a price worth paying if you can save a boatload of interest. Like most big financial decisions, it depends on the particulars of your situation.
Given how egregious most credit cards rates are, as well as the size of your total debt, I’d give a promotional offer some serious thought. I don’t know the interest charges you’re paying on your current accounts, but let’s conservatively take 20 percent APR as the average. If you’re simply staying afloat when it comes to your principal, you guys will fork over nearly $3,600 throughout the year in finance charges alone. No wonder card issuers are about as well-liked as a canker sores.
A lot of cards offer zero-percent APR for the first nine to 15 months (if you qualify, that is), which would give you some serious relief from those insane rates. And a few, like the Chase Slate card, won’t charge you a balance transfer fee as long as you roll over your existing balances within 60 days (a three to five percent fee isn’t uncommon).
That said, there are a few things you want to think about before pulling the trigger. Lenders tense up a bit when they see you’ve applied for new accounts within the year, since they don’t know yet how you handle paying them off. So it can ding your credit score.
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But here’s the thing: “new credit” only comprises 10 percent of your FICO rating, the most widely used credit scoring system. As long as you’re only signing up for one new card, it should be a pretty minimal hit. And given the potential savings, a short-term drop in your FICO shouldn’t put you in a cold sweat – especially if you’re not going to be buying a home anytime soon.
Keep in mind, too, that 100 percent of each payment during the promotional window will be going against the card balance, since there’s no interest to pay. So you can potentially hack away at your principal a lot faster this way. And the fact is, account balances are a bigger factor in your FICO score than taking out new credit. So in the long run, a new card could actually raise your score.
However, it is important to know what you’re getting into with a transfer. During the stretch when you’re paying zilch in finance charges, it’ll seem like you’re on easy street. After that, expect some whiplash. As of this writing, the Chase Slate, for instance, spikes up to anywhere between 17.24 percent and 25.99 percent variable APR when the intro period comes to a halt. And the introductory rate usually only applies to the balances your transfer over. You’ll find that they’re not so generous when it comes to new purchases.
The other risk, of course, is that you actually start using the additional credit you have at your disposal. The fact that you guys have racked up high balances means you’re in deficit-spending mode. That has to change. If you do take out a new card, use them just enough to avoid having the bank close your account for inactivity. Use it to pay off the phone bill or something. But don’t leave it in your wallet or linked to your Amazon account, where temptations abound.
The bottom line is this: if you can use the promotional rate to aggressively pay down your balances, and you’re not going to applying for any big loans in the near-term, switching to a new issuer can make a lot of sense. But keep your reading glasses handy – you really need to understand the fine print first.
Now, there are some alternatives when it comes to lowering your interest rate. For instance, if you have a fair amount of equity in your home, you could apply for a home equity line of credit, or HELOC, which will typically have an interest rate that’s a heck of a lot lower than that of a card. But there are perils with this, too. You’ll have to pay closing costs in order to open up a credit line, and you could lose your home if you don’t make your payments on time.
Taking out a personal loan is yet another way to pay off your card balances. The rates aren’t quite as low as HELOCs, but they’re generally better than most Visas or Mastercards. Given your debt, however, it’s not a sure thing that you’ll get the lender’s best rate. So, by all means, weigh the pros and cons of each before proceeding.
Of course, the mechanism you use to pay off your balances is only part of the equation. The more important element is actually having a plan to pay down your debt. The first thing you guys need to do is cut all the useless crap out of your budget. And if you do take out a new card, I’d urge you to set up an automatic payment each month for as much as you can. The whole point of that low initial rate is to aggressively pay down the principal and finally get that albatross off your neck.
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