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Scott:
I've been a faithful reader of your newsletter for about 6 months
now and you have a lot of great information packed into it. My
question is this. I received an offer from Discover for a no fee,
balance transfer with 0% APR for life of the unpaid balance, as long
as I make a purchase each month after July 2005. I'm tempted to take
up this offer to get some of my other cards that are at a higher
rate moved to this. I've talked to them previously and they said the
purchase could be as small as a pack of gum. Is there a catch here,
(other than I see you need to never be late with a payment)? If
you've written about this before could you tell me where I can see
this info. Thanks for all your help.
Sincerely,
Mark
Mark,
I recently received this very same
offer! Additionally, I was interviewed by SmartMoney.com's Aleksandra
Todorova for a feature story that talked about it as well titled, Free
Cash!
 This is certainly one of the most
creative transfer offers I've seen of late. The idea of 0% APR
forever, the life of the loan, is almost too good to be true. And of
course, as you have guessed, it is too good to be true. However, it
still may be very good depending on how you can use this offer.
We all know that there isn't any bank
on this planet that is going to propose a deal that will not
make them money. Yes, they're making money on this, and it's okay,
the question is just how much and is it worth it for us to use the
offer.
This offer presents a very interesting
math problem. As always, you need to know the question before you
can get the answer. So the question is simply this, "What is
the true interest rate (true cost) if I take advantage of the 0%
forever transfer offer, when all the fees and terms are taken into
consideration?"
I've posted the actual letter that
I received about the offer. All the deals are contained in here.
To figure out if the offer is worth
it we must first take a look at all the terms:
| 1) |
0%
forever with conditions |
| 2) |
Must
make $50 in purchases starting with billing period that ends
in June 2005. Since I received the offer in January that means
about 6 months without having to make any purchases if I took
advantage of this offer right away. |
| 3) |
Balance
transfer fees of 3% of the amount transferred with a $5
minimum and $50 maximum. |
That information is still not
sufficient to determine the true cost of this deal. You still need
to know the purchase rate for the card, current balance, maximum
available credit, how much you want to use for the 0% deal, and how
much you're going to pay per month.
Keep in mind that payments will be
applied to the balance in a manner that makes the most money for
Discover. That manner is to apply those payments to the 0% deal
first and thereby, effectively, locking in all other balances, and
future purchases, at the high purchase rate. See my article, How
banks use low rate offers to lock in high rates for more on
that.
Here are the numbers, from my
account, for these other details:
| 1) |
Purchase
rate 19.99% |
| 2) |
Purchase
balance $0 |
| 3) |
Maximum
$11,500 |
| 4) |
For
three examples I want to use $10,000, $2,000, and $1,000 for
as long as I can at the 0% forever rate. Therefore, I will
make minimum payments of 2% of my balance (not lower than $10)
until the 0% portion of the balance has expired, at that time,
I'll pay off the entire balance. |
Tip: Be sure that your balance
is zero before taking advantage of the offer. Do this by
transferring that balance to another card first. Then, write the
transfer check to yourself and pay off that card.
Math details for the below examples
are here.
| Example
#1: |
| 1) |
Purchase
rate is 19.99% |
| 2) |
$10,000
is cash advanced at 0% for life ($50 cash advance fee) |
| 3) |
Charges
build at $50 per month |
| 4) |
Minimum
payments are made on the account, which are equal to 2% of the
account balance. At that rate, the 0% balance is repaid in 72
payments. |
| 5) |
At
that time, the entire balance is paid off since the "0%
for life" is over. Life in this case was 72 months. |
| 6) |
The true cost for the money is 6.07% APR. Still very good but
certainly not 0% because of the purchases being locked in at
19.99%. |
| Example
#2: |
| 1) |
Purchase
rate is 19.99% |
| 2) |
$2,000
is cash advanced at 0% for life ($50 cash advance fee) |
| 3) |
Charges
build at $50 per month |
| 4) |
Minimum
payments are made on the account, which are equal to 2% of the
account balance. At that rate, the 0% balance is repaid in 45
payments. |
| 5) |
At
that time, the entire balance is paid off since the "0%
for life" is over. Life in this case was 45 months. |
| 6) |
The true cost for the money is 9.79% APR. This makes sense
because I'm using less money at 0% as a proportion to the
balance that being charged 19.99% |
| Example
#3: |
| 1) |
Purchase
rate is 19.99% |
| 2) |
$1,000
is cash advanced at 0% for life ($30 cash advance fee) |
| 3) |
Charges
build at $50 per month |
| 4) |
Minimum
payments are made on the account, which are equal to 2% of the
account balance. At that rate, the 0% balance is repaid in 36
payments. |
| 5) |
At
that time, the entire balance is paid off since the "0%
for life" is over. Life in this case was 36 months. |
| 6) |
The true cost for the money is 11.35% APR. Again, this makes
sense because I'm not using as much of the 0% money. |
| Conclusion: |
| 1) |
It's
not really "0% forever." |
| 2) |
The
math has shown, in my examples, that the best rate was 6.07%,
a far cry from zero. |
| 3) |
The
more money you can use in the offer the better the true
APR. |
| 4) |
Forever,
even at minimum payments, is only a few years because it's
measured by how long at least some of the balance stays at
0%. |
| 5) |
Be
sure that you know the true rate for your situation before
taking advantage of the offer. You don't want to think that
the rate is 0% and payoff a 9.99% card when the true APR
is really 11.35%! |
Note: Calculation of true APR.
The True APR, or rate of return on investment, or any periodic-rate
for any period, can be determined using a Present Value analysis on
the Cash Flow. In other words, the sum of the present values of the
cash flow for all periods must be equal to 0. The rate of return
that makes that sum equal to 0 is the true APR (periodic rate).
The present value for any discrete
period is A*(1+apr/12)^-n where A is the periodic cash flow, and n
is the period number. In my analysis, I use the convention that
positive money is received and negative money is spent (goes away
from me). For example, spending $50 on the credit card is +50
because I received $50 from the bank (money to me), conversely if I
make a $125 payment it's -125 because that is money leaving my
hands. Therefore, the cash flow for that example period would be -75
(50-125).
How's that for a long-winded answer
to your question, Mark? 
Best,
Scott
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