Revisiting Anna: 30 Minutes, $3,000 Saved, a Life Transformed

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In June, I wrote a post about a woman named Anna. In under 30 minutes at a seminar hosted by my company, MagnifyMoney.com, we were able to help her save more than $3,000 by moving her debt from a high-interest credit card to one with a much lower interest rate using a balance transfer.

Anna had lost her job as a teacher. It took her a year to find a new one, and during that year she burned through her emergency savings and accumulated $12,000 of credit card debt. All of that debt sat on a Discover (DFS) credit card, at a 21 percent interest rate.

$210 a Month for Credit Card Interest

Anna was working hard to make a $250 monthly payment on her credit card. And $210 of that payment went to interest. She felt trapped, poor and depressed.

But Anna was responsible. And although $12,000 was a lot of debt, her credit score was well above 700, because she paid her bills on time and hadn't maxed out all of her cards.

Anna had come to our financial literacy seminar looking for answers. She was drowning in debt and had fallen for some of the biggest personal finance myths out there. Namely:
  • You have to be rich to have a good credit score, which isn't true. The most important part of your score is paying on time and not maxing out your credit cards. Your income or net worth is not part of the score.
  • Banks and credit card companies reward loyalty. Also not true: Especially with credit cards, the best deals are given to new customers in the form of switching bonuses.
  • If one bank rejects me, they will all reject me. False again. Every bank has its own approval policy. The only way you know for certain what an institution will do is by applying.
  • Applying for a credit card will kill my score. A new application will take an average of 10 points off your score, temporarily. That can be important if you are applying for a mortgage within the next six to 12 months. But, otherwise you shouldn't worry. The point of a credit score is to use it to get the best deals and save money.
  • Balance transfer fees are too high. That usually isn't true. Rather than letting fear guide you, do the actual math and see if the fee is worthwhile.
We helped Anna use MagnifyMoney.com to find the best balance transfer offers for her credit score. The site also calculates and shows how much you can save (including the fee). We helped her transfer $7,100 to a Barclaycard (BCS) (0 percent for 24 months with a 4 percent fee) and $1,000 to PenFed (no fee, 4.99 percent for 48 months). These balance transfers reduced her monthly interest expense from $210 to $70 in the first month alone. By slashing her interest costs, Anna could put more money towards principal reduction, cutting years off her debt repayment.

As I said, that all happened back in June. This month, I was back to Tennessee to host more financial literacy seminars, and Anna asked to see me. I was worried, because I thought she had more bad news. But, instead, I saw a smiling Anna. She'd come to thank me, because she finally saw a light at the end of the tunnel. I used that opportunity to get an update, and I thought I would share that update with the DailyFinance readers.

Bank Approvals

We had counseled Anna to apply for three credit cards, because her score was in the high 700s and she wasn't planning on applying for a mortgage any time soon.

Barclaycard and PenFed had approved Anna. Santander (SAN) referred and eventually rejected her.

If she'd started with Santander, and given up when it turned her down, she would never have saved all that money. So if your score is above 700, don't be afraid to apply to multiple banks. They don't all have the same rules, but your FICO score is only an indicator of your likely success in applying, not a guarantee.

Credit Score

We had warned Anna that her score would drop a bit after she applied for those three credit cards, and it did. Anna sees her FICO score on her monthly Discover statement, and it dropped into the high 600s the month after the card applications. But, four months on, it's above 700 once again, and I expect it will continue to increase over time.

Remember that the two most important factors in your score are paying on time (which Anna always did), and utilization (the percentage of your available credit that you use). Along with the length of your credit history, they represent 80 percent of your FICO score. When Anna opened two new cards (from Barclaycard and PenFed), she added $8,100 to her total available credit, which cut her utilization ratio. Anna hasn't spent more on credit, and continues to pay down debt aggressively. So her balance is dropping quickly, further improving that ratio.

Taken together, those moves will cause her score to improve. So, if you do apply for few cards, don't be afraid of the initial score drop. Just stay disciplined and don't spend on those credit cards, and the rebound should appear.

Fees

To complete her balance transfer, Anna was charged $284 of balance transfer fees (4 percent of the $7,100 transferred to Barclaycard).

In the first month, her interest bill was only $72, compared to $210, a savings of $138. In just three months, Anna will have saved more on interest than she paid for the balance transfer. And she keeps the 0 percent on Barclaycard for two years and the 4.99 percent rate on PenFed for four years. The fees definitely paid for themselves.

Doing Business With Better Organizations

One part of our conversation really struck me. Anna told me that she felt good about paying the interest to PenFed. Discover was just trying to take advantage of her situation. And the 0 percent offer from Barclaycard was a transaction. But PenFed was simply charging a fair interest rate, as opposed to an obscene one.

I am a big fan of PenFed and regularly write about how credit unions offer some of the best lending products in the country. But with Anna, I saw that financial reality as it applied emotionally. If banks really want the loyalty of people like Anna, they need to create simpler, cheaper, more transparent products.

What You Can Learn from Anna

If you want to save money, you need a good credit score. But don't overcomplicate the process. As long as you pay your bills on time and don't max out your credit cards, you will end up with a good credit score.

But once you have a good score, you have to use it. The single best way to accelerate your debt repayment is to cut the interest rate you pay on your debt. And the best way to cut those rates is make banks compete for your debt, and move your debt to the bank offering the lowest rate. Anna's story is just one more example of how easy it can be to save a lot of money, and of how good it can feel when you do.

Nick Clements is the co-founder of MagnifyMoney.com, a website that makes it easy to compare the true cost of financial products. He spent nearly 15 years in consumer banking, and most recently he ran the largest credit card business in the U.K.

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Revisiting Anna: 30 Minutes, $3,000 Saved, a Life Transformed
Yes they can.

The CARD Act did get rid of the most outrageous abuse: they can no longer increase the interest rate on existing balances unless you go 60 days past due.

However, you need to remember that:
  • Most credit card interest rates are variable and are linked to the prime rate. Your high rate will only go higher when interest rates increase.
  • Based upon risk, your credit card company can still increase your interest rate on all future purchases. Your existing balances are protected, but future purchases would be at the higher rate. And determining risk is not limited to your behavior on your existing card. If you miss a payment with another lender, that could lead to an increase on all of your credit cards.
  • After 12 months, they can increase your rate for almost any reason. But the increased rate only applies to future purchases, and they need to give you 45 days notice.

Credit cards are incredibly expensive ways to borrow money. If you use a card, your goal should be to pay off the balance in full every month. Then, the interest rate doesn't matter.

Bottom line: If you do have debt, you should never be paying the purchase APR. Look for a balance transfer, or get a personal loan to cut your interest rate. And take a long hard look at your spending to put more money towards paying off that debt.
 

No, they are not.

There is a big difference between a 0% balance transfer (where the interest is waived during the promotional period, discussed above) and 0% purchase financing offered at many stores (where the interest is only deferred).

I regularly encourage people to use balance transfers to help them pay off their debt faster. With a balance transfer, interest is switched off or reduced during the promotional period. Once the promotional period is over, interest starts to accrue on a go-forward basis. This can take years off your debt repayment.

But stores offer 0 percent financing at the checkout. With a lot of these programs, interest is charged from the purchase date if you do not pay off the balance in full during the promotional period. So, if you have a 12-month 0 percent offer -– and do not pay off the balance in 12 months -– then in month 13 you will be charged a full 13 months of interest. They retroactively charge interest, and it will be like you never had a 0 percent offer at all.

 

This is a common practice. Online, Apple (AAPL) does this, via their partnership with Barclaycard (BCS).

And stores like Walmart (WMT) do the same thing.

Bottom line: I don't like deferred interest deals. Most people do not understand the difference between waived and deferred interest, and this practice feels deceptive. If you take one of these offers, make sure you pay off the balance in full before the promotion expires.
 

Not always.

Credit card companies have different rates for different types of transactions. The interest rate charged on a purchase (high) is different from a balance transfer APR (low).

Before the CARD Act, banks would apply your payment to the lowest APR balance first. Imagine you have a $1,000 balance. $500 is at 0 percent (balance transfer), and the other $500 is at 18 percent (purchase). If you make a $100 payment, banks would apply that to the balance transfer. That way, they reduce the balance transfer (at 0 percent) to $400, while protecting the $500 purchase balance (at 18 percent).

The CARD Act changed that. Banks now need to apply payments to the highest interest rate first. But this only applies to payments higher than the minimum due.

If you only pay the minimum due every month, your payment will still likely be applied to the lowest interest rate balance first.

Bottom line: You should never spend and have a balance transfer on the same credit card. Banks can only "trap" balances when you have multiple balance types on one card.
Not exactly true.

The CARD Act has stopped the handout of T-shirts on the steps of the school libraries, but they can still give sign-on bonuses. And they advertise on campus. For example, Citibank (C) has a "Thank You Preferred" card for college students. If you spend $500 in the first three months, you get 2,500 thank you points as a bonus. That is $25 of value.

Bottom line: I actually find this worse. Before, you got a free T-shirt just for signing up. Now, the credit card companies encourage spend on the card for the "free gift."

In the past, banks would charge you a fee if you went over your credit limit. Today, the CARD Act requires banks to receive your consent to charge an over-limit fee. So, in most cases, banks just eliminated those fees -- which is good news (kind of).

You can still go over your credit limit, if the bank approves your transaction. But the full amount by which you've exceeded your limit will be part of your minimum payment come the next bill, which could cause a payment shock.

More importantly, utilization (the percentage of your available credit that you use) is a big factor in your credit score. Your credit score determines the price you pay for credit. So, if you're over-limit on an account, you are considered riskier. That can result in the credit card company increasing your interest rate. And it could also result in other lenders increasing your rates with them. So you do pay, but it's an indirect cost.

Bottom line: We're glad the fee is gone, but you still need to be diligent and try to avoid going over your limit. If you pay your balance in full every month but are frequently bumping up against your credit limit, ask for a credit line increase.

Completely false.

I have heard from so many people that the way to eliminate overdraft fees is to opt out of overdraft protection. But it is impossible to completely opt out of overdraft.

Federal regulation requires consumers to opt into overdraft protection only for debit and ATM transactions.

But, the regulation does not cover checks and electronic transactions (including bill-pay and monthly direct debits, like gym memberships). The banks have all the power. If they approve the transaction, you would be charged an overdraft fee (typically $35 per transaction at banks and $25 at credit unions). If they decline the transaction, then you would be charged an NSF fee (non-sufficient funds), which is usually just as expensive as the overdraft fee.

Bottom line: You can't opt out of all overdraft fees. To avoid them, keep a buffer or find an account, like Ally, that doesn't charge those junk fees.
Not always true.

To be protected, you need to report the fraudulent transaction within 60 days. Otherwise, you give up a lot of your rights.

On ATM/debit cards, the bank can make you responsible for up to $500 of fraud if you report more than two days (but less than 60 days) after the transaction. On a credit card, you would never be liable for more than $50 (and most banks won't even hold you accountable for $50.)

One area where you will almost always lose is when your Personal Identification Number is used. If someone manages to get your PIN and takes money out of your account, then the bank will almost always assume that you authorized the transaction. Make sure you change your PIN often and never write it down.

Bottom line: Avoiding liability it your responsibility. Track your transactions regularly and call as soon as you detect any suspicious activity. And make sure you never share your PIN with anyone, or make it obvious.
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