7 Steps to Make Credit Card Debt Work FOR You
July 28, 2011NOTE FROM LIZ DAVIDSON, FOUNDER AND CEO OF FINANCIAL FINESSE, ABOUT THIS POST: The strategy Erik discusses below has huge risks if you are not extremely financially disciplined. Most of us aren’t. Erik Carter happens to be the most financially disciplined person I’ve ever met in my life, so I can see how he was able to use this strategy without over-extending himself and getting into serious debt problems. If you are one of the few who is like Erik, this is a great strategy. Otherwise, it has the potential to lure you deeper into debt and you need to be very careful to implement it the right way and avoid the temptation to spend money you don’t have.
With that, here’s the post– hope you enjoy it:
Yes, you read that title right. (I warned you that some of my posts would sound crazy at first, didn’t I?)
Financial planners like to talk about the evils of carrying credit card debt and it’s usually true. The average credit card balance of households with credit card debt is $10,000. If that typical family has the average credit card balance interest rate of 14% and pays a minimum payment of $173/month, it would take more than 20 years to pay the balance off and they would pay almost $27K in interest over that time. That means they would have paid in interest to the credit card companies almost twice as much as they originally spent!
And what did they get for $27k (other than instant gratification)? Absolutely nada. I don’t know about you, but I can certainly think of better ways to spend that money. That’s why we planners suggest paying off credit card debt as a top financial priority. (Another way to look at it is since a penny saved is a penny earned, every dollar you put towards paying off that debt early is like earning a guaranteed 14% tax-free on that dollar. Pretty nice, huh?)
However, there is one way to make credit card debt actually work for you. It’s a technique that I discovered out of necessity. When I first started working in the brokerage business, most of my income was from commissions. As someone who had just graduated from college, moved to a new area of the country, didn’t know anyone with a lot of money, looked even younger than my 21 years, and was working for a company with hardly any name recognition there, let’s just say that things got off to a bit of a slow start. There were some months where I was a bit short and even had to borrow money from my roommate to help pay the rent. I was always able to pay him back from a future commission check, but this situation was certainly not ideal for anyone involved.
To help smoothen things out, I found a way to borrow money from credit cards with no or low interest. (I define low as less than what I could earn from the bank.) That certainly beats running up high-interest credit card debt, or even worse, taking out a payday loan in an emergency. If you have existing credit card debt, you can also use this method to reduce the interest rates you’re currently paying and avoid the fate described above. So here’s how it works:
1) First, you need credit cards with low balance transfer offers (ideally 0% but a 1.9% forever might be better in the long run). You can also do this with low purchase rates offers, but it’s less effective. While these offers tended to dry up after the financial crisis, they’re now coming back with full force. If you’ve opted out of credit card offers, you can opt back in at optoutprescreen.com to start receiving them again. You can also shop for them proactively at sites like creditcards.com and smartbalancetransfers.com.
2) The better your credit, the more and better offers you’ll qualify for. I was 21 yrs old with a correspondingly short credit history when I started this, but credit card companies have raised their standards since then. If you need to, click here for some ways to improve your credit.
3) When you’re comparing credit card offers, don’t stop at the balance transfer rate. Look also at how long you’ll get the low rate, how much of a balance transfer fee you might have to pay, and whether it’s offered by the same bank as a credit card you already have (more on that in a moment).
4) Once you get your card, call the credit card company and ask to consolidate the credit limits from any other credit cards you have from the same bank. For example, if you have a Bank of America Visa with a $20k credit limit and your new Bank of America card with a 0% balance transfer offer has only a $1k credit limit, you can transfer the $20k limit to the new card and now have the 0% on $21k! Just leave some of the credit limit (maybe $500) on the old card so it doesn’t close. You may get a new 0% offer on that card after the current one runs out. In that case, you’d just transfer the credit limit back.
5) Once you’ve consolidated credit limits at the lowest possible rate, you can use it to pay off higher interest debt if you have any. If not, you can do what I did and ask for an “indirect balance transfer.” Just provide them with your bank’s information and they can automatically deposit up to $11k in this case right into your bank account. If you never need the money, you can just sit back and collect the interest, which can be up to 4% in a rewards checking account. That’s over $1,200 of free money with an 18 month balance transfer of $21k.
6) If you miss a payment, you’ll likely lose the balance transfer rate, plus you’ll get hit with fees and it could hurt your credit score, so set up the minimum payments to be automatically deducted from your bank account.
7) Keep track of when the balance transfer offer runs out and make sure to pay it off before then with either the money in your bank account or another balance transfer offer. Rinse and repeat.
I’ve since found out that other people have been doing the same thing and calling it “credit card arbitrage.” One person even created a calculator so you can see how much you can earn.
There are a few possible downsides of course:
1) Having more credit cards with full balances on them will hurt your credit score, so don’t do this if you’re applying for a big loan like a mortgage anytime soon. That being said, the hit to your credit score is relatively small and you can always bring it back up by paying off the balances if and when you need to. I’ve done this for about 10 years without it hurting me in any way.
2) You have to be organized and possibly keep track of several credit cards with different dates for when you have to pay off the balances.
3) You could blow the loan money on something stupid.
This strategy won’t make you rich, but I’ve earned thousands of dollars from it with about 10 minutes of work a year. More importantly, it could save you even more than that in interest payments if you have existing debt, or help you get through a temporary rough patch without paying high interest rates or depleting your emergency fund. Credit card companies have been trying to take advantage of us for decades, isn’t it time to turn the tables?