Monday, September 17, 2012

Do Balance Transfers Always Make Sense?

Balance on this!
If you've ever carried a balance on a credit card, you've probably also considered setting up a balance transfer to "hide" that balance and not pay interest on it for a while. I don't know about you, but I receive a handful of balance transfer offers in the mail every month, and those "0% APR for 12 month" offers can be very tempting.

But hang on a second. Does it always make sense to transfer a balance from one credit card to another, even at 0% APR? Let's take a look at the fine print.

I was perusing just such an offer from Discover Card when I saw that the balance transfer charged a 5% immediate fee to facilitate the transfer. Big deal, you might say. If I'm being charged a 19.99% APR on another credit card, surely paying 5% instead makes more sense.

The problem comes from just how that interest is charged. As I stated, the 5% charge is immediate, but what you might not realize is that the 19.99% charge is spread out over the year. What does that mean in real figures?

If you transfer $1,000 to Discover, you will immediately pay a $50 fee to do so. This balance will not be charged interest for a year, however.

If you kept that $1,000 on the original card at 19.99% interest, you would only face an interest charge of $16.66 the first month. This is because while the interest is higher, the charge is then divided across the 12 months. Therefore, your monthly interest charge equals $1,000 X .1999 / 12 = $16.66. With this being the case, it would take over three months for that $1,000 on your original credit card to cost you in interest what you'd be paying immediately with balance transfer.

What should you do in this situation? It depends on how quickly you can afford to pay down this debt. If you think you pay an extra $333 per month towards the principal, it makes more sense to keep it on the original credit card (particularly since the interest will be reduced with each payment). If, however, you think you need to pay this amount down over the course of a year, then the balance transfer is the better option.

So what should be your takeaway? Balance transfers are the Trojan Horses of personal finance, and, in this case, it makes a lot of sense to look this gift horse in the mouth.

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Wednesday, September 5, 2012

Lending Club Update - September 2012

As you can see in the graphic to the right, I'm finally out of the negative return area with Lending Club. In fact, since the last time I posted an update, my returns have increased by roughly 5%. To make sure my returns increase, I've changed how I look at investing with Lending Club.

How, specifically, have I adjusted my investing strategy with Lending Club? Well, in the first place, I've increased the number of loans that I hold. As I mentioned before, having so few loans in the first place is really what caused the one default to affect my returns so grievously. As of today, I have 36 loans, all of which are current in their repayment. I do plan to keep investing more with Lending Club, but I'm holding off until I get a better sense of how much I'm going to be able to work when I go back to grad school in a few weeks.

The other way that I've changed my strategy is that I am much more vigilant now concerning late payment. As you may know (and as you probably know if you're reading this in the first place), Lending Club has a trading platform with which you can sell off any of your notes at whatever price you choose (assuming you can find somebody to buy them). The drawback is that Lending Club charges a 1% fee per note sold.

How exactly have I been more vigilant? Well, as soon as I notice that one of the people that I've lent to misses a payment, I put their note up for sale. I start the price at what is owed plus the current amount of interest, and I adjust that price downwards every few days until somebody purchases it. My thought is that it's better to get most of my money back on that note, even if I end up selling it for a loss. That is, a small loss is more appealing to me than the prospect of getting larger returns due to extra charges to the borrower that accompany late payment with the risk of a large loss (the entire value of the loan).

Perhaps I'm oversensitive on this topic, but after the one note defaulted (by someone who later filed for bankruptcy), I want to limit my risk with the notes as much as possible. As I mentioned, Lending Club does charge late fees for people who are late with a payment (which would mean extra money if the borrower brings themselves up to date with their payment), but I'm a happier person by selling the notes off and not having to worry about them.

What do you think? Am I too conservative in my Lending Club approach? Let me know in the comments.