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The Cost of Free Money
By Karen Hube, May & June 2006
With credit card teaser rates at zero, you can just keep debt moving from one bank to the next—can’t you?
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Helen Ashton, 58, wants to spend her $1,500 tax refund. She could use a few rooms repainted at home, a bigger television, and some new clothes. Her only hesitation: $10,000 she owes on credit cards. While that sounds like a lot, Helen says it hasn't cost her. She keeps shifting the balance to new cards that waive transfer fees and charge no interest for the first six or 12 months.
The Problem
Helen, who earns $55,000 a year as a hospital administrator, knows it would probably be wise to put a dent in her debt, yet with monthly expenses under control, she wonders if there's really any harm in letting things ride. Helen carries the burden on two cards, has been paying about $200 a month, and puts new charges on a third card that she pays in full monthly. She figures if she can keep ducking finance charges she'll be debt-free in five years.
Helen's not alone on the slow boat to solvency. Among low- and middle-income households with card debt, 29 percent owe more than $10,000. And according to a new study conducted for AARP, 21 percent of women ages 45 to 59 say they never pay their entire credit card debt. (Read our article "The Secret Lives of Single Women.")
As clever as Helen has been about juggling her accounts, she's playing a dangerous game, says Lynn Ballou, a financial adviser in Lafayette, California. "Those zero percent offers could dry up," she says. "After you hop from card to card for three or four years, banks start wising up to you."
And a recent effort by Helen to tidy her debt by closing old accounts may backfire. With the limit on her three cards at $13,000, she's using three fourths of her available credit. "The more you're maxed out, the more it hurts your credit score," says Evan Hendricks, author of Credit Scores & Credit Reports (Privacy Times, 2005). "Ideally, you should keep debt to 30 percent of your limit."
Late payments, a threat to every cardholder's wallet, are a particular hazard for Helen. Under "universal default" rules some banks imposed recently, any late payment—be it on a mortgage, car loan, or card—can bump your charges to the company's ceiling, transforming a no-interest bonanza into a disaster at, say, 29 percent a year.
The Plan
Helen's best bet is to put the painters on hold and use Uncle Sam's check to drop her balance to $8,500. Rather than wait for another tax refund, she might lower her withholding, boost debt payments—and put a little more away for retirement. "This will help her not just financially but psychologically," Ballou says. "Watching debt decline and savings rise could inspire her to stay on course."
Monthly payments of $350 would cut her debt to $4,300—a third of her limit—in just a year and wipe it out in two, freeing Helen to save even more.
For those who do pay interest on card debt, bigger payments may be something to get used to. New federal banking guidelines mean cardholders must pay all interest charges and fees each month plus at least 1 percent of the principal. That adds up to higher minimums for many—but a shorter, cheaper loan in the end.
Karen Hube is a financial writer in Westport, Connecticut.
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