Word Problem

Submitted by adammyerson on Thu, 05/14/2009 - 16:04

I hope you've been studying. Here goes: A business owner has a goal to reduce his overall debt, but also remove pressure from the monthly budget. Said business owner has a credit card with a $16,000 limit, a 13.25% rate, and a $5000 balance. Additionally, said business owner also has an auto loan with a $300 monthly payment, 6.5% rate, and a $2300 balance. Now, let's say the credit card company offers said business owner a check with certain perks and restrictions. Said check provides 0% APR for 6 full billing cycles, but carries a 3% fee on the transaction amount. After the 6 months, the rate on the balance returns to the 13.25% APR. In 2009, said business owner has been typically making $3000/monthly payments on the credit card in order to pay it down, reducing the balance by approximately $1000/month. Assume for this word problem those payments will be maintained. Your question: should the business owner pay off the auto loan with the credit card check, knowing the above parameters, and taking into consideration the freeing up of the $300 monthly auto loan payment?

 

Comments

Submitted by dave (not verified) on Thu, 05/14/2009 - 18:17.
according to my paper napkin calculations, you'd be saving a grand total of around $30
Submitted by dave (not verified) on Thu, 05/14/2009 - 18:20.
more (around $105?) if you take that $300 car payment and put it towards the credit card every month...
Submitted by bsegal (not verified) on Thu, 05/14/2009 - 19:03.
I know you've been busy racing, but there's a credit crunch going on from just such investment decisions. On the surface, yes "said business owner" consolidates his debt. however, if an UNEXPECTED DOWNTURN IN THE ECONOMY happens, you, I mean he is fucked. A larger debt at a higher interest rate is going to cost you significantly more right? The only reason the credit card company makes this bet is because they are counting on a large percentage of folks racking up debt that they can't really ever pay off. That's how they win. Unfortunately, they are only satisfied when they have you over a barrel with no option but to give them all you have. There's a reason that nobody goes on and on about how much they love their credit card company. The evil greedheads have a very slick sales pitch, and it's exactly how we got into the mess we're in now. Don't trust people who only benefit when you lose. told as a friend. watch thine ass
Submitted by colinr (not verified) on Thu, 05/14/2009 - 19:54.
I assume this is a thinly veiled attempt to get us to do your finances, but whatever, I'm a sucker for math. Transferring the $2300 car loan to your credit card will cost you a mere $69 (3% of $2300), and you won't pay anything else on that transfer until 6 months from now, at which point you'll only have $500 left on the car (because you're still putting $300 a month toward it, it's just on your credit card now). At that point you now have $500 at 13.25% and you're out the $69 for the transfer. If you don't use the check, then you have to keep paying off your car loan while it accrues intererest at 6.5%... or 0.5416% a month. 0.54% of $2300 is $12.45 in interest in the first month, but since your balance goes down each month it will be less than $12.45 for each future month. I'll spare you the math, but you won't even pay $69 in interest on your current car loan in the next 6 months, and it won't go to a higher interest rate after those 6 months -- so you current car loan is better using the check in every way.
Submitted by JDBilodeau (not verified) on Fri, 05/15/2009 - 07:42.
How about snowballing? I think that got your attention.... Don't use the check. When you use a check or a cash advance, they do not allow you to pay off that debt first- meaning you'll pay a higher rate on it for a long time. Your payment gets split (and you can't dictate the split) some towards balance, some towards transfer. Instead, rather than paying off new charges plus 1K on the card, pay only new charges for two months. Take the 1k and pay off the car in two months. $1k plus $1k plus 1 payment. Thus you pay out the same per month for 2 months, but eliminate one bill entirely. Your credit card balance stays neutral for 2 months but you avoid the 3% transfer fee. What you hope to do is to then take the money you would have spent on the car and spend that on your credit card. It's called snowballing, because it's like rolling a snowball down a hill- as you eliminate bills, you roll those payments into your other bills to reduce them faster. You're tempted by the no interest for 6 months, but the fee essentially replaces that. And of course even if you intend to pay off the card in 5 months there is always the possibility that you could run into unexpected expenses. Like a family of flying squirrels destroys part of your house, your washing machine dies, your cat needs to go to the emergency vet in the middle of the night with an impacted anal gland.... you know, the kind of stuff that happens to me each month. I'm just saying is all
Submitted by Adam Myerson (not verified) on Fri, 05/15/2009 - 08:05.
Ziemba posted this on FB, saying he couldn't get here for some reason: "anyways... if you have a 0% transfer balance, AND a regular balance, your payment will go to the higher rate first. In other words, it will keep paying your main balance for that 6 months, and then when its all done, that car balance will now be up to 13.25% rather than the 6%" That is a crucial detail, and the strongest argument for not using the check to consolidate the date. JD's suggestion to pay off the car ASAP and hold steady on the CC, even thought the CC has the higher rate, seems like the best compromise between removing a payment (the auto loan) to increase cash flow, and paying down the higher rate card ASAP.
Submitted by jjziemba (not verified) on Fri, 05/15/2009 - 09:39.
sorry, i missed that you were still using the card for monthly expenses. and I COMPLETELY messed that up. payments always go to the LOWER rates first. Banks want to keep as much as they can on that higher rate. (sorry, i was having my TV Party while writing that). so if you transfer over $2300, but the next month make a $3000 payment, it will pay off your car in 1 month, saving you $53 in interest, but costing you $69 in transfer fees, plus the additional interests on your outstanding balance. If the whole purpose is to "free up" that $300 then your best bet is to just pay the car off in full one month, then get back on the regular payment plan of the credit. not the best financially, but best option if the $300 is needed for other expenses. sorry for the confusion
Submitted by jjziemba (not verified) on Fri, 05/15/2009 - 09:45.
yeah... when I say they pay the lower, i mean, they pay "most" of it to the lower... there is a split, but as JD says.. you can't dictate what it is. but its a pretty high percentage.
Submitted by JDBilodeau (not verified) on Fri, 05/15/2009 - 10:37.
As a follow up, there is also an advantage to paying off the car in that you get the title. And that means since you own the vehicle free and clear you can switch your auto insurance from a comprehensive policy (which your loan holder requires) to the Mass Minimum policy. Which should save you money if you are willing to accept the greater risk of the minimal policy.
Submitted by colinr (not verified) on Fri, 05/15/2009 - 13:11.
WTF is an "impacted anal gland?" Sounds like JD's cat has been riding too much. So we all agree -- don't use the check.