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Balance-transfer debt consolidation

Dear Debt Adviser,
I read not to borrow from one credit card to pay off another. I have approximately $4,000 on several other cards and have an empty one that is offering a 5.6 percent for the life of the loan. Is it OK to get the $4,000 to pay off the other credit cards (which I intend to close afterward)? That way, I have only one card, one finance charge and one payment. Smart move or not? What is the downfall? Thanks for your advice.

Dear Diana,
Smart move! Maybe.

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Several people have written to me asking why I would advise that borrowing from one card to pay another is bad news. Let me clarify. What I mean by that is paying one minimum balance, by increasing the balance on another card. A pyramiding of debt!

What you are proposing is not what I have warned against. You are asking about the advantages and disadvantages of transferring balances from several cards perhaps at a high or variable rate to one credit card with a lower, fixed-interest rate.

Combining your balances on to one credit card is essentially your own personal consolidation loan. The difference between what you are doing and a true consolidation loan is that you can add purchases to the card that you are using to consolidate your balances. Also watch for balance-transfer fees that may increase your real cost of consolidation.

The first rule of successfully consolidating your balances on one card is that you must have the discipline to stop increasing your debts. The biggest mistake you can make is to continue to charge. I wouldn't recommend that you close all the accounts that you will be paying off. If you did, you would have to use the card with the transferred balances for any purchases you will be paying off in full each month. Be careful of this, as new purchases are usually at a higher rate and you pay interest from the day of purchase without the usual grace period. Also having some open accounts will help your FICO score.

My suggestion that you not charge anything you can't pay off in a short time also applies to consolidating credit card balances through a home equity loan. You must be very careful of any additions to outstanding balances or you will end up in the same, if not a worse, boat -- one with a big money leak.

The second disadvantage is the fact that, unlike a home equity loan, your credit card company has the right to change the terms of your current agreement under certain circumstances. Your 5.6 percent interest rate could get hiked up to 25 percent or more if you miss even one payment, and you would have no choice but to pay the higher interest charges.

The most obvious advantage to consolidating your credit card balances is to save money. Your $4,000 in balances on several cards could be costing you as much as $65 a month in interest charges. However, the charges per month on the credit card with 5.6 APR would be approximately $18. Bankrate has a calculator that lets you figure out the real cost of any credit card debt.

Another advantage to your plan of consolidating balances is that you can pay off what you owe faster and save a bundle. Here's some fun with numbers: If you pay a 2 percent ($80) minimum payment on $4,000 at 18 percent you will pay $10,931 in interest over 508 months. If you pay the minimum payment with a 5.9 percent interest rate you will pay off the debt in 195 months with interest of $1,216. But my favorite is to continue to pay the $80 minimum at 5.9 percent interest and you will be done in 58 months for an interest charge of only $602. See the Bankrate "True cost of paying the minimum" calculator and do some figuring yourself!

Diana, it sounds as if you have the discipline to make your plan work and now you know the real costs of paying now or paying later. Good luck and remember: No charging!

The Debt Adviser, Steve Bucci, is the president of Consumer Credit Counseling Service of Southern New England. Visit CCCS for additional debt advice or click here to ask a debt question.

-- Posted: April 16, 2004



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