A reader asks which is a better way to pay off a $5,000 balance: a low-interest balance transfer card or a loan.
Dear Maturing Loans,
I receive many offers for credit cards, but my question is this: What’s a better deal — a low introductory interest rate balance transfer card or a simple loan? I have a balance of $5,000 and have received the following offers: a card with a 0 percent interest rate for six months on balance transfers, a 3 percent transaction fee and a 9.9 percent interest rate after six months; or a loan with a 3.99 percent interest rate for its life and a 3 percent transaction fee. — Rivets
You have asked a good question — and an important one for many people. Let’s take a look.
First, a 3 percent transaction fee on a $5,000 balance transfer would equal $150.
In comparing these scenarios, we will assume you keep the balance the same — at $5,000 — and you pay down the interest cost. This way, we are not calculating interest on interest.
Scenario 1: A credit card with a 3 percent transaction fee plus a 0 percent introductory APR for six months on a balance transfer plus a 9.9 percent interest rate after six months
In this scenario, you would pay the aforementioned $150 transaction fee but no interest on the transfer itself for six months. Then, the 9.9 percent annual percentage rate would kick in. Assuming the $5,000 balance total, you would generate $247.50 in interest over 6 months.
That means that for the first year that you have the credit card, it would cost you $397.50 — the $150 transaction fee + $247.50 in interest.
In the second year and every year thereafter, you would be charged $495 (9.9 percent interest times $5,000) in interest, noncompounding for the year.
Scenario 2: A loan with a 3 percent transaction fee and a 3.99 percent APR
In this scenario, you would pay a $150 transaction fee plus $199.50 (3.99 percent APR times $5,000) in noncompounding interest. That means that for the first year, you’d be charged $349.50.
In the second year and every year thereafter, you would be charged $199.50 (again, 3.99 percent APR times $5,000).
So which is best?
Given all of this, what’s the answer to your question? It depends on how long it takes you to pay off your loan. The longer you go, the better Scenario 2 (at 3.99 percent APR) looks versus the 9.99 percent APR in Scenario 1.
- Scenario 1 total cost for first year = $397.50.
- Scenario 2 total cost for first year = $349.50.
- Scenario 1 total cost for first two years = $397.50 (first year) + $495 (second year) = $892.50.
- Scenario 2 total cost for first two years = $349.50 (first year) + $199.50 (second year) = $549.00.
You are better off in Scenario 1 only if you hold the loan for less than 10 months.
- Scenario 1 total cost for 10 months: $150 + $0 for six months + $41.25/month for four months = $315.
- Scenario 2 total cost for 10 months: $150 + $16.63/month for 10 months = $316.30.
Still, no matter which you choose, please try to pay down the debt as time goes by and keep your interest costs down.
Thanks for the question, see you back here next week.
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