Zero Interest Credit Offers
The Pros and Cons of Zero Interest Credit Offers
Zero interest rate offers by credit card companies on transferred balances or new credit cards are as relentless as they are ubiquitous; but, do they make sense for your client?
There are a number of benefits and drawbacks to such zero interest promotions that must be considered before your client decides to accept the offer.
Potential Benefits of a Zero Interest Rate Offer
1. Zero Interest!
If your client has any outstanding unsecured debt, like from a credit card, the interest rate may be as high as 20 percent per annum or more. Even a modest credit card balance of $5,000 can mean up to $1,000 or more in interest payments every year.
Saving the interest charges for the period during which a zero interest rate applies, typically six to 18 months, may translate into meaningful savings—savings that may be used to reduce debt or fund an IRA or Health Savings Account.
2. Funding Large Purchases
Your clients may be faced with an unexpected large outlay, such as major repairs or the need to attend a destination wedding. In other cases, your clients may simply want to make an expensive purchase, like a vacation.
Whatever your client’s situation, access to interest-free credit can help manage cash flow and keep emergency funds intact. The borrowing costs may be nil, provided the full amount is repaid prior to the expiration of the zero interest rate period.
3. May Simplify Debt Repayments
If your client has multiple card balances, consolidating them via a zero interest rate balance transfer may have the added benefit of simplifying monthly payments by reducing the number of creditors to pay and the transactions to track.
Potential Drawbacks to a Zero Interest Rate Offer
1. The Zero Rate Ends
Though Federal law requires a minimum of six months, the zero interest rate only lasts for a prescribed time period. After that, your client will be paying interest on any remaining outstanding balances. Depending on the rate offered and the previous rate they were paying, your client might be paying as much or even more interest once the zero interest rate period expires.
2. It’s Not a Cure for Bad Behavior
For individuals with spending behaviors that send them into excessive debt, the transfer of debt to a zero rate may only be a bandage. Sure, it will save your client some money and help them to repair some excessive debt challenges, but it does nothing to mitigate or eliminate the underlying problem—too much spending.
In fact, the transfer of high-cost debt to a zero interest rate balance may exacerbate your client’s bad behavior since it may free up, at least temporarily, cash for more spending.
The costs of excessive debt are not measured in financial terms alone. High debt levels may cause stress that can negatively affect the emotional and physical well-being of your client. If a client has a debt problem, consider helping him or her with the issues that lie behind the accumulation of debt, rather than focusing on a quick fix with little potential to be a lasting solution.
3. Balance Transfer Fees May Apply
Zero interest rate promotions often have balance transfer fees that may be 2-3 percent on the amount transferred. While this may appear inconsequential in relation to the eventual savings that will be realized over the 12 to 18 months that a zero rate may apply, it is nonetheless a cost that will add to overall debt balances.
If the client has funds in a bank earning no interest, it may be more financially advantageous to use those savings to retire the outstanding balance on his or her credit cards and save on the balance transfer fee.
4. A Client’s Credit Score Could be Hurt
An individual’s credit score could potentially drop since opening a new credit card and the associated decline in the average age of the credit profile may lower their existing credit score. Moreover, if the card from which the transfer is being made is left open, it could result in a higher credit utilization. This could result in a negative impact for future credit applications.
Because a lower credit score may result in higher costs in other parts of a client’s life, the balance transfer may prove to be more expensive than imagined.
Read Before Leaping
Before accepting any zero interest rate offer, your client needs to read the fine print. Make sure he or she understands:
• The annual percentage rate after the zero rate period has expired
• What the balance transfer fee is
• The time period for no interest charges
• The minimum monthly payment
• What the cap is on balances that can be transferred, if any
• Under what conditions the zero rate may be rescinded, e.g., late payment
• Whether the minimum monthly payment amount is applied against existing high interest balances first or against the zero rate balance
A Final Word to Advisors
Excessive spending is frequently a symptom of a larger problem, such as compulsive behavior, depression or low self-esteem, among other conditions.
Because we live in a materialistic society, these afflictions may often manifest themselves in spending, whether to gain social acceptance, feel better about one’s self or to satisfy an uncontrollable inner drive.
In such cases, therapy or financial counseling may turn out to be an individual’s most important investment.
See referenced disclosure (2) at http://blog.americanportfolios.com/disclosures/