By STEVE BUCCI
bankrate.com
Monday, July 30, 2007
Dear Debt Adviser,
I have consolidated all of our credit card debt onto two credit cards with APRs of 4.99 percent and 2.99 percent until it is PAID OFF. My husband wants us to take out a loan with the bank so that we are making set monthly payments even though the interest rate would be considerably higher, possibly around 11.25 percent.
I have tried to explain to him that we would be paying more money that way, but he does not understand. Can you explain it in a way he can understand or am I somehow looking at this wrong? -- Susan
Dear Susan,
I can tell who's the most fun at your house! You clearly like an unstructured approach that allows for side trips when something interesting comes along. The old "ball and chain" likes a direct approach with few unknowns and a clear end to the journey. In the end, the only right answer is the one you both agree on. Either approach to paying down your debt will work.
Still, there are some tangible factors I can suggest that may help. You are of the school that the less money you pay in interest charges, the better the loan. Depending on how long it takes you to pay off the balance, you could be right. However, depending on what little surprises life has in store for you, maybe not.
A downside of using credit cards to consolidate debt is the not-so-nice universal default clause that is included in many cardholder agreements. If you are late making a payment on the credit card account in question, if your credit score or history changes substantially, or if you are late with a payment to another creditor, your rate can be raised to the default rate -- usually in the ballpark of 30 percent.
Optimist that you are, I have a feeling that this eventuality will have little impact on your sunny outlook for using the cards. So, consider this. With most cards, once you carry a balance over a month, new purchases are charged interest immediately. Not at the nice rates for a balance transfer, but at the market rate of about 18 percent. But wait, there's more! Any payments you make go to the lower interest rate balance first. So before you can shut off the new high interest finance charges you will need to pay down the low interest balances completely, which could be years.
One last point and then I'll pick on your husband some more. If your new card balances as a result of the transfers are more than 50 percent of the maximum limit, then your credit score will take a hit and you will be one step closer to an unexpected universal default than you thought!
Now, let's look at the bank loan that your husband favors. As you can see above, you might or might not pay more interest this way. But life will be more predictable. This may be what is partially behind his concern.
The other concern I see relates to why you are carrying credit card debt large enough to need to consolidate it! Perhaps the easy going approach to finances is concerning him and a more disciplined repayment plan will assure that this little bundle of joy gets paid off and leaves the nest before it eats you out of house and home.
My suggestion is to combine the benefits of both approaches in the interest of marital bliss. Leave the debt on the cards if you want the interest savings, but arrange for an automatic payment equal to the amount of the installment loan payment to be sent directly from your bank account each month.
This will pay down the debt in less time than the time the installment loan would have taken, which will limit your exposure to the unpleasant surprises I mentioned and still assure you that you will have a definite ending point. Remember, do not use those cards until they are paid off.
Good luck!
(Steve Bucci is president of Money Management International Financial Education Foundation. Visit www.moneymanagement.org for additional debt advice. If you have a question for Steve, e-mail debtadviser(at)bankrate.com. The Debt Adviser is a weekly feature of bankrate.com. For more stories visit scrippsnews.com)
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