One of mankind’s greatest inventions is credit cards. Ironically it has also become one of mankind’s greatest curses.
In the Philippines most credit card companies charge 3.5 % interest rate per month. That is about 42 % per annum. Using the Rule of 72, (which I have extensively discussed in the post entitled “How to use the Rule of 72 to wisely manage debt”) your present debt will double every 2 years. So, if your credit card debt is P 10,000.00, in 2 years time it will become about P 20,000.00.
The best solution is of course to pay all your credit card debt immediately. That is if you have the money to do so. But what if your credit card debt amounts to P 100,000.00 or even P 200,000.00 what should you do? What if you have multiple credit card debts? Here are some great suggetions:
1.) Obtain a debt with a lower interest rate – Some lending institutions and even banks offer an interest rate of 0.99 to 1.5 % interest per month. This is much lower than what the credit card companies charge. Use the loan to pay off your credit card debt, and resolve to never ever again to use your credit card except if you can pay it within 30 days. That way you won’t be charge the monthly interest. By borrowing at a lower interest rate you will minimize your losses due to interest. Borrowing from somebody with 0 % interest is even much better. (A rich old uncle perhaps) If you have several credit card debts, borrow enough to pay all of it. This way you can focus on paying only one debt and one interest rate. In financial planning this is better known as “debt consolidation.”
2.) Avail of balance transfer – Most credit card companies have a wonderful feature called “Balance transfer.” This simply means you transfer your credit card debt from one credit card company to another. When you transfer your balance from other credit cards they will give you only .99 percent interest per month. This is already a steal deal. Balance transfer are payable in certain terms like 12, 24 or 36 months. What’s good about this is that most credit card companies offer no fee balance transfers. (In some countries they call this 0 apr balance transfer) So let’s say you have a credit card debt of P 100,000.00 with credit card A. and you have another credit card which we will call as credit card B. Your credit card B has a credit limit of P 100,000.00. What you could do is you could transfer your debt from A to B. Instead of being charged 3.5 % interest per month for your credit card debt by credit card A, Credit card B will only charge you 0.99 % per month (About 12 % per annum).
Credit card B will add the monthly interest and then divide that with the term that you wish to avail of. For example of you wish to pay off your debt within a year the computation would be: interest multiplied by principal+ principal divided by 12. So that would be 12 % x P 100,000.00 + 100,000.00 / 12 = 9,333,33. Your credit card debt will then be only P 9,333.33 per month.
If you say that you will just pay P 9,333.33 per month at 3.5 % per month anyway that is based on “diminishing interest” (This means that your interest goes down if your principal goes down)as opposed to paying a “fixed interest” you will still end up with P 14,822 in credit card debt at the end of the year. However, if you pay a fixed interest of P 9,333.33 at the end of the year you will end up with zero debt.
But if you pay only the “minimum” per month, what will happen ? If you do the math, you will see that at the end of 12 months your credit card debt will still be P 92,585.00. That is why it is not wise to pay only the “minimum.” So it is best to avail of a 0 balance transfers.
There are several things to remember about “balance transfer”:
1.) Balance transfer is subject to approval by your credit card company.
2.) The maximum amount you can avail of is your credit limit. Let’s say you have P 100,000.00 and you used up P 50,000.00 more or less you can balance transfer about P 50,000.00. However take note, this is not guaranteed. This is still subject to approval by your credit card company.
3.) Make sure you pay the fixed monthly installment. In our illustration above, pay the P 9,333.33 religiously, otherwise it will be made subject to the 3.5 % monthly interest. Don’t be tempted to pay only the “minimum” since you will be charged with 3.5 % interest over and above the 0.99 % interest. If you will only be the minimum you are subjecting yourself to double jeopardy!
4.) It is advisable to use your credit card when you are using your card for balance transfer in order to avoid confusion and to make sure that you can make a priority to pay the installment for balance transfer.
5.) Resort to balance transfer only when you cannot avail of the first option. The first option (Get a loan with a lower interest rate) is still the best.
Earl Wilson once said, “Today, there are three kinds of people: the have’s, the have-not’s, and the have-not-paid-for-what-they-have’s.” Those caught in credit card debt belong to the last category. Make sure you are not one of them!