Would we save money by moving the debt to a lower interest credit card?

August 19, 2008 3:35 PM

Personal Finance 101: Is it smart to pay off an auto loan at 10.25% interest with a credit card that has a 6% interest rate?

My husband has a $7700 balance on an auto loan with an interest rate of 10.25%. I have a credit card with a gigantic credit line that has an interest rate of about 6%. Does it make sense to switch the debt over if we continue to make the same monthly payment? Obviously, I want to minimize the amount of interest that we pay, but I don't really understand if auto loans and credit cards compound interest in the same way or not. So I don't know if this is a smart move. However, I really want to get out of this auto loan that has such a high interest rate! Would we save money by doing this?

We're in the US, if that makes a difference.

Thanks in advance!

posted by crunchtopmuffin to work & money (23 comments total)

Lower interest rates are always better. Check to see if there is a pre-payment penalty on the car loan. Sometimes you have to pay extra to pay off the loan early. Other than that it seems like a fine idea.
posted by GuyZero at 3:39 PM on August 19, 2008

I could be nuts, but I have a hard time believing your credit card's interest rate is really only 6%. Are you sure it's not 6% plus prime, or something like that?

If the TRUE interest rate is really below 10.25%, then moving it makes sense. However, you should be very careful about the differences in penalties and rate increases for late payments. It may be the case that if you make a late payment or carry a balance for more than X days/months, your rate could jump to something huge.

Either way - I'd really recommend double checking the true interest rate of your credit card, because 6% seems very low to me even for a great credit card. If it's really 6% - it might be an introductory rate (i.e. only lasts for a # of months), or a rate on balance transfers that also only lasts some number of months.
posted by twiggy at 3:44 PM on August 19, 2008

If you are thinking about doing a "balance transfer", or use checks your credit card company has mailed you, be very wary of the transaction -- most credit cards charge a 3%-5% fee, and sometimes without a limit to the amount. 6% + 3% is close enough to 10.25% that you probably wont realize much of a benefit.

But even at 6%, you will only save ~$40 a year on interest, and even less as you pay down the principal. In my opinion, it is not worth moving debt from a secured account (lien holder on your car) to unsecured (credit card debt) over $40/year in interest. We are looking at a credit environment where some issuers might not look kindly on a sudden $7700 charge, or the related FICO credit score drop related to that.

If you were talking about a 0% offer, I might be a bit more supportive, but at 6% you are realizing little benefit for quite a bit of risk.

You could easily save $40 in interest by paying down on the principal of the secured 10% loan.
posted by SirStan at 3:45 PM on August 19, 2008

Second SirStan, this seems risky for not much gain. Credit card terms are usually a lot more draconian than car loan terms, especially when it comes to balance transfers. Only do this if you have a very good understanding of the terms of both the loan and the credit card.
posted by burnmp3s at 3:51 PM on August 19, 2008

Are the 10.25% and 6% figures both stated as APRs? (effective Annual Percentage Rate) If you're not sure, ask, so that you can do an apples to apples comparison. All lenders are legally required to provide APRs on request, if not published.

My gut feeling is, for the same reasons others have expressed, that this is too good to be true. Credit card companies are experts at the bait and switch.
posted by randomstriker at 3:51 PM on August 19, 2008

Is the 6% rate on your CC permanent, or is it a short-term teaser rate? If it's permanent, it makes sense to transfer the balance, as long as there is no prepayment penalty (as GuyZero notes)...IF you have the discipline to make the same payment to your credit card every month that you are now making to the auto loan. Since the minimum payment on your credit card will be much lower, some people might be tempted to pay less each month. That could be painful or even disastrous.
posted by brianogilvie at 3:53 PM on August 19, 2008

Thanks, all. This is all really helpful.

twiggy: Yes, the credit card really, really has a rate of about 6% (I'd have to look up the exact rate). I've had this card forever (so it's not an introductory rate) and I've never made a late payment or really ever carried a balance. So I would need to look into penalties/change in terms for carrying a balance.

SirStan: I don't get your calculation of $40/year. Based on my (very cursory) calculations, we'd be saving something like $180 a year. The current term of the loan is about 27 more months. Is there something I'm missing?

Also, I guess I should have asked if auto loans and credit cards compound interest differently. Or am I really comparing apples to apples here (aside from all the fees, etc.)?
posted by crunchtopmuffin at 3:55 PM on August 19, 2008

For what its worth, Pentagon Federal Credit Union has 5.99% ballance transfers for life -- so there must be others out there that do the same. So this is not an unheard of rate. (Ps-They also have a great used auto rate -- It might be worth looking at them).

(Full disclosure, member of Penfed, no interest in the organization otherwise).
posted by SirStan at 3:57 PM on August 19, 2008

crunchtopmuffin: "Thanks, all. This is all really helpful.

SirStan: I don't get your calculation of $40/year. Based on my (very cursory) calculations, we'd be saving something like $180 a year. The current term of the loan is about 27 more months. Is there something I'm missing?

No... you are right... can someome explain what I did wrong? It seems like the monthly interest should be:

$principal * (0.01025/12) = ~$6 for $7700?

But clearly -- it isnt? (My interest was $30 last month on a $6k ballance at ~5% apr, but it was a 14k loan over 48 months).
posted by SirStan at 4:02 PM on August 19, 2008

I was half-heartedly looking into doing this a while back. The risk that appeared was that credit cards are (generally?) not a fixed-rate, while car loans often are. This was an issue because at the time, banks were (and are) doing things like hiking 8% credit card rates to 15% overnight without warning, as they try to protect themselves from the ongoing US finance meltdown.

If the car loan is not fixed-rate, then this doesn't apply. But it seems unlikely that you have a credit card where the terms prevent the bank changing the interest rate (for any reason or no reason whatsoever), so there is a risk that that might happen and so that the scheme might not pay off. But then, you don't get reward without risk either.
posted by -harlequin- at 4:07 PM on August 19, 2008

The killer here will be the balance transfer fees, or the higher interest rates on checks you draw against your credit card account. Banks aren't stupid. You won't find a way to game the system.
posted by Cool Papa Bell at 4:09 PM on August 19, 2008

Cool Papa Bell: "You won't find a way to game the system."

Fatwallet.com -> Finance Forum -> Look at the NUMEROUS "AOR" threads. People ballance transfer thousands to hundreds of thousands of dollars on 0% offers all the time and make a small fortune on banks.

Gaming the system is entirely possible, as long as you know all of the rules (Chase keeps offering me 0% with no ballance transfer fees for a year -- which I would gladly use to pay off my car if they would up my limit to something acceptable to do so -- but ballance transfering $5k onto a $5k card would tank my credit score for too long to make it worth it.)
posted by SirStan at 4:11 PM on August 19, 2008

crunchtopmuffin: "Thanks, all. This is all really helpful.

SirStan: I don't get your calculation of $40/year. Based on my (very cursory) calculations, we'd be saving something like $180 a year. The current term of the loan is about 27 more months. Is there something I'm missing?

Ah, sorry -- I am sick. I missed a decimal place with my numbers. Based on equal payback schedules (one at 10%, $331.50, and one at 6%, $331.50) you will be paying back $919 interest with your 10% loan, and $505 interest with the 6% loan. So you are looking at a $400 savings over the next 27 months, or just over one car payment.

To me, $400 is still to little to gamble with financially, and hurts your credit score for too long. You could save that same $400 in other ways (unplugging wallwarts, turning the temperature down, filling up your tires with air, not buying that morning latte, etc).

Its good to look at ways to cut costs, but this cost cutting measure has to many unknown risks for me to ever recommend to you. If you decide to go after this, please be extremely careful that you make EVERY payment on time atleast a week early, as missing a single payment could push you into a default rate that would quickly make this a horrible deal for you.
posted by SirStan at 4:20 PM on August 19, 2008

So Stan's final thought, refinance, dont move it to unsecured debt.
posted by SirStan at 4:21 PM on August 19, 2008

Gaming the system is entirely possible, as long as you know all of the rules

Which banks change without warning. Often.

But hey, whatever, man. You can wave to me from your yacht.
posted by Cool Papa Bell at 4:35 PM on August 19, 2008 [1 favorite]

The mathematical answer is, you would save $200 over the course of 27 months IF a) Your credit card rate is fixed, not variable; b) Your credit card company doesn't decide to unilaterally jack up your rate (which isn't a given).

Gross interest savings would be $430. But after you account for a 3% balance transfer fee (equal to about $231), your net savings are only $200.

There are a variety of issues here that haven't been discussed.

1) I don't think your credit card rate is fixed, I think it's variable. I only know of ONE bank in the entire country that offers a 6% fixed rate on their credit card, and the chances that you happen to have them are slim. Variable rates are great in an environment when interest rates are falling, but there is a chance that in the next 6 months interest rates will rise again. I don't know how likely that is, per se (even the people who make that decision don't know right now), but it's a risk. In addition, banks are tightening their lending right now. Unless your FICO score is impeccable, you run the risk of having your rates increased (But probably not so much as to make this deal unprofitable.)

2) You're saving $200, AND giving yourself flexibility to pay less than $320 a month (which is what I calculated as your monthly payment right now). What is that flexibility worth to you? Would you rather have the discipline of the term loan, or the flexibility and option of a credit card?

3) Just remember why your credit card company is doing this. They collect an upfront balance transfer fee, and hope and pray that you decide not to pay back the card. Is it a deal? Yes. Is it saving you money? Yes. Are you now at the mercy of the credit card company? YES. With your auto loan, there are no gimicks, changes to terms, or surprises. You pay it off in 27 months and that's that.
posted by SeizeTheDay at 4:59 PM on August 19, 2008

Whoops. $168 net saved, not $200. Not a particularly attractive savings, and as it comes closer to zero, the risk of your variable rate increasing between now and 27 months from now becomes more important.
posted by SeizeTheDay at 5:22 PM on August 19, 2008

To answer the basic question, yes, they are calculated the same way. They might vary on when the interest is compounded, but on that size of a loan, it doesn't really make a difference.

Very basically, it works like this. If your rate is 12% and you have monthly payments, they take the amount you still owe on the statement date and multiply that by your rate / 12. That, plus the principle amount, is your monthly payment. Next month, your principle is lessened by the amount you paid in principle last month. Credit cards do the same thing, but I believe they calculate it daily (rate / 365), but still bill you monthly.

Yes, I'd be wary of using the credit card. You'd probably save just as much by adding another $20 or so to each payment or taking the amount you'd have paid in balance transfer fees and making a one-off extra payment.

And if the CC company raises your rates (which they often do after they get your debt), you're screwed.
posted by gjc at 5:28 PM on August 19, 2008

My credit union is currently offering used car loans at just over 5%, with no fees for the refinance, which would be both cheaper and less risky than your credit card solution. This assumes you have a decent credit score, which is likely if your credit card has a low APR.

Call some credit unions and see what your local options are.
posted by Forktine at 5:31 PM on August 19, 2008

gjc: "And if the CC company raises your rates (which they often do after they get your debt), you're screwed."

This is something most consumers do not realize -- You always have the right to not accept the higher interest rate. You can simply call up the credit card, and cancel the account. You will then be allowed to continue repayment with your previous contracted rate.

So the CC company could change the rate from 6% to 12%, but you can say "no thanks", close the account, and continue on your marry way making payments.

Naturally if the 6% is introductory, or requires "3 purcahses a month" to maintain, the canceling the card game doesn't work.
posted by SirStan at 5:50 PM on August 19, 2008

I don't know, but maybe someone else will: Does your credit rating get built differently depending on the type of loan/debt and repayment? This is something to consider, as credit scores are the real game being played here.
posted by Riverine at 6:32 PM on August 19, 2008

gjc touched on this, but I'll elaborate: I have sometimes kept modest loans with fixed payments even though they have higher interest rates than my credit card (or home equity line) because fixed payments and no "available credit" to access means they actually get paid off. Since you don't carry a balance on the card, perhaps this wouldn't apply to you, but at our house we sometimes find that the increased flexibility of a credit line rather than a fixed loan just means it doesn't get paid off as fast, because we reduce our payments if we have a minor crisis or whatever.

Sometimes when making financial decisions, it's not just the numbers on the paper that matter, but your psychology and behavior patterns as well.
posted by not that girl at 7:09 PM on August 19, 2008

Most points covered so far, but just to make this explicit: If you use this credit card for ANY other purchases, you will not have a grace period and will be paying 6% from time of purchase since you are carrying a balance. If you get the card and ONLY use it once to transfer your car payment then you can avoid these charges.

I pay my cards off every month, but every couple of years a payment is a couple of days late. Once that happens, I start to pay interest on the balance (naturally) but also on any future purchases as the 30-day grace period is gone. So the next month, I get another interest charge. And then if those two payments aren't late, then I get my 30 days grace period again.

As others have mentioned, the credit card companies are sleazy bunch. I wouldn't try to game them unless you know exactly what you're doing.
posted by kamelhoecker at 8:33 PM on August 19, 2008