You will be able to calculate whether a balance transfer actually saves money once the fee and the promotional period are included.
Aisha has a second problem besides the dental bill. Over the past few months S$5,000 has built up on her credit card, and each month she has paid a little more than the minimum. Then a letter from another bank arrives offering 0% interest for six months if she moves the balance across. Zero sounds hard to beat. The letter is right that it can save her money, but only if she does three things the letter does not mention.
A balance transfer moves debt you already owe to a new facility at a low or zero interest rate for a fixed promotional period, often a few months to a year. In exchange you usually pay a one-off fee, typically a percentage of the amount transferred. Some balance transfers pay off a card balance directly, while others pay cash into your bank account, which you then use to clear the card. The terms say which, and the effect is the same: the old debt is cleared and you owe the new lender instead.
The promotional rate applies only for the promotional period. When it ends, whatever you still owe moves to the facility's normal rate, which is usually high, often close to card rates. That date matters more than anything else in the offer.
Here is Aisha's case with example figures. The offer is 0% for six months with a one-off fee of 3% of the amount transferred. On S$5,000 the fee is S$150.
If she leaves the balance on her current card at an example rate of 26% a year, the first month's interest alone is about S$108. If she clears it from her card in six or seven months with payments of about S$833 a month, she pays roughly S$416 in interest along the way. With the transfer, her cost is the S$150 fee, as long as she clears the balance within the six months. The transfer saves her about S$266.
The fee is not free money, so it helps to see it as a rate too. Paying S$150 to borrow a reducing balance of S$5,000 over six months works out at an EIR of about 10.5% a year, using the same RATE method as the flat rate loans in lesson 3.1, Personal instalment loans: fixed payments on a flat rate. That is far cheaper than card interest, though a long way above the 0% on the letter.
The transfer only saves money if the balance is gone by the end of the promotional period. That requires a specific monthly payment, and you can work it out in one line: divide the balance by the number of months in the promotion.
For Aisha, S$5,000 divided by 6 is about S$833.33 a month. If the fee is added to the balance instead of charged separately, the figure is S$5,150 divided by 6, about S$858.33. Either way, that is the payment the plan needs, and it is far more than the minimum the new lender will ask for.
Suppose she pays S$500 a month instead, because it is what she is used to. After six months she has paid S$3,000, and S$2,000 is still owed when the promotion ends. That S$2,000 moves to the normal rate. At an example 26% a year, it costs about S$43 a month in interest from then on, and she is back where she started, with a smaller balance but no cheap rate.
Some people then move the remainder to yet another 0% offer and pay another fee. Each fee is small, but they add up, and each new application leaves an enquiry on the credit report, which lesson 1.3, What moves your risk grade up or down, warned about.
The other way a balance transfer fails is quieter. The old card is now clear, the limit is available again, and the habits that built the first S$5,000 are still there. If new spending goes on that card and is not paid in full, Aisha ends up with the transferred balance and a fresh card balance at the full rate.
Some balance transfers also come with conditions on new spending. If the transfer sits on a card, new purchases on that card may be charged interest straight away, much as lesson 2.1 described for a carried balance. Read the terms on how repayments are applied and whether new purchases get an interest-free period.
A balance transfer works when three conditions all hold: you can make the payment that clears it within the promotion, you stop adding new card debt, and the fee is smaller than the interest you would otherwise pay. If any one fails, the cheap bridge can end up costing more than staying put.
Aisha's next step is to find a real offer and put its actual terms into the same sum: the promotional rate, the length of the promotion, the fee and the rate afterwards. With those four, the monthly payment the plan needs is one division away.
For a S$5,000 card balance, work out the monthly payment needed to clear a balance transfer within its promotional period, using a real offer's terms.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).