Credit cards: Beware that balance transfer

What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries.

1. Downsides of balance transfers
2. Needs, wants, and emergency funds
3. Handling risk intolerance
4. Converting debt into student loans
5. Taxes and freelance work
6. Income-based repayment
7. Handling new annual fee
8. Buy or repair?
9. Paying cash for a car

Laura Nyro is one of my favorite musicians. She was a singer and composer of jazz, gospel, rhythm and blues, show tunes, pop, and rock music whose popularity peaked in the late 1960s, but she’s most well known for a pile of songs she wrote for others. Strange, really, because I find her own renditions of a lot of the songs to be superior and far more soulful. I think her shyness (which comes out in interviews) may have played a part in her relative obscurity. I’d suggest a YouTube search for “Laura Nyro” if you’re curious.

Anyway, why mention her? I came across a quote from her recently that I’ve been thinking about a lot. I’m just going to share it with you without comment.

“As beautiful as simplicity is, it can become a tradition that stands in the way of exploration.”

Q1: Downsides of balance transfers
My husband and I have broken every rule in your book, and are paying for it now. We are at retirement age and are thoroughly unprepared, but still lucky, since we both have legacy pensions from employers to fill in the gaps.

One specific question I have has to do with our high interest credit cards. We have been receiving lots of offers from other credit cards for balance transfers at 0% interest for 12-13 months. We would have to get 3 or 4 of these types of accounts in order to eliminate interest for a year. And then we’d have to transfer again next year, in order to maintain a 0% APR.

Assuming we could remain disciplined while we go thru this, is there a down-side to taking this approach?
- Rita

You make the assumption sound trivial, but it really isn’t. Companies offer such balance transfers because they know that the ability of someone in debt trouble to “remain disciplined” really isn’t all that high.

A balance transfer is what it is on the surface. They’re offering to essentially give you a 0% interest loan to pay off another debt you already have. That 0% interest loan comes with caveats. It will reset in a year. Depending on the agreement, you may have to pay back the interest you would have earned during that year.

Before you do this, make sure you have a cash emergency fund and a step-by-step plan for paying off this debt. Without them, you’ll be in even deeper trouble in a year.

Q2: Needs, wants, and emergency funds
I guess I have two different money problems, so I’ll start with the easiest to explain, need vs want. I’m 24 year old student so money is quite tight as I’m paying my own tuition fees at £3,290 a year I’m not very good with budgeting and wondered if you had any great tips or advice with someone who wants to learn to start and my main problem is with excess money, as soon as I have any I spend it stupidly. And I need to stop doing that but my problem is figuring out the difference between need vs want and quality vs quantity. This recently hit me when I bought a cheap jumper that after three wears it got a hole in the back and had to buy a replacement. I thought if I’d bought a more good quality one it would have a longer life span and would be able to wear it more. Sadly although this idea is great I only had a certain amount of money to buy a replacement jumper and it wasn’t the price for a good quality one so I had to again settle for a cheaper alternative now this jumper is already wearing thin! But the end of winter I’d have bought three jumpers which in the end would have cost the price of one good quality jumper but I didn’t have that amount at the beginning to buy one decent one. How do I stop this from happening again?

Next it’s possibly quite silly but, I have a pair of boots I wear every winter for the snow they were a gift at £60 and every year for the last 5 years I’ve had to get them resoled at £15 this now makes the resoles more expensive than the boots and I don’t know whether it would be better to save up for next winter and spend £100+ on some better soled boots from an outdoor shop or to just continue spending £15 every winter on getting the boots resoled. It’s a really silly thing to get stuck on but its been plaguing since November!

The final part is my laptop has broken I’m trying to find someone to repair it and if I can’t I will have to buy a new one! But I have no savings, I’d be able to get one on finance but it’s not ideal as it would make money even tighter for my partner and I. We’re both mature students but my partner makes more money than I do working and gets more financial help from the University than I do so he often helps me out when things get extremely tight. If it came to getting a new laptop my partner would end up paying most of the payments for me, which I see as unfair as he’s trying to pay off his credit card that he ran up before we became students, it was at £2,000 I can’t remember what it’s down to right now. Ideally we’d both like it if I could use his computer but we’ve both had essay deadlines at the same which would make it impossible for us to share his computer. I don’t know what the best way to handle this situation would be, if my laptop was unrepairable!

And lastly, back in September 2009 I had a £500 emergency fund that I’d saved before becoming a student due to the possibility that it might take me a while to find a new job as we moved from one side of the country to the other and incase there was a family emergency and I had to get home asap as the train ticket would have been £100. Sadly, both things happened, I was unable to get a job and in January 2010 my father had a stroke was taken into hospital and two weeks later in was diagnosed with liver cancer during the second week of February I was told to come on asap as he didn’t have long left to live. This came as a shock to me, my partner and my mother. I ended up leaving university due to the grief and missing a month of university left me so far behind I was unable to catch up. During 2010 my partner and I went back to visit my mother three other times not including the february visit which meant we spent £600 in total just on travelling that we had no way budgeted for. I was unable to get a job for the whole of 2010 due to being so depressed and the £1645 of tuition fees that I didn’t have to pay as I’d left after just the first term I spent on travelling, bills, food, books and lots of random junk that was very unnecessary, which has now made everything really tight for me as I started back at University in September 2010 without any money. I really need to start a new emergency fund that would at least cover £100 incase I needed to go back home if something happened to my mother but I can’t see how to squeeze anything else out of my current budget when I’m trying to pay my tuition fees that are due 28th April! I suppose ideally I could cut down my repayments on my credit card its £250 and I wanted to pay it off this year and be done with it. The payments are £5 a month but I get £4.36 a month interest so I’m paying off £15 if I cut it back down to £5 a month I have the problem that eventually it’ll go over the limit and I’ll get charge £12 for going over and then it’s a never ending spiral of trying to pay my way out of it, as I found out during 2010!

If it was a great world I’d happily wait til I’d paid my tuition fees off in April but the problem with that is once I pay them off I have to save up again for the next year only in September 2012 am I able to get financial help for my tuition fees but the problem is getting there! I’m really not quite sure what to do!
- Ally

As I read this story, I kept asking myself questions like

Does she really need to have her boots resoled?
Does she really need a laptop?
Does she really need to be buying new clothes?

What I see in your story is a bunch of expenses that are completely unnecessary for a debt-burdened college student. Go down to your local secondhand shop or thrift shop and buy some cheap shoes and whatever clothes you can find. Don’t buy them new. Use the computer resources of your campus instead of buying yourself a new laptop.

If your reaction to this response was, “Well, that’s no help!” then you’re not really willing to dig yourself out of the situation you’re in for want of stuff.

Q3: Handling risk intolerance
After losing a considerable sum in the tech stock fall (way back when) and then a huge sum in a failed real estate investment,
we are now extraordinarily ‘risk intolerant’.

At 46 years old and 52, we have what’s left of our retirement in an online savings with Dollar Savings Direct…..(making ‘bupkus’ as my old Grandma would say)…but, it’s safe. We know we are not even keeping up with inflation but don’t have the stomach (or the time before retirement!) to lose any more money. We’ve become ‘chickens’!

Any advice?
- Laurel

Baby steps.

If you’re earning 1% interest in your account, put 1% of that somewhere where it’s at a higher risk. Even if you lose all of that, you’re still breaking even.

Next, if you’re earning 1% interest in your account, put 5% of that balance in a higher risk investment. Even if that high risk investment loses 20% of its value, you’re still breaking even.

Once these steps seem okay, start moving toward what a retirement portfolio should look like for your age, probably something like 30% stocks and 70% conservative investments (cash and bonds).

If an investment is keeping you up all night out of stress, it’s not worth it.

Q4: Converting debt into student loans
I make about $33,000/year and am currently $27,500 in debt. About $15,000 of that is VERY high interest rate credit card debt (between 24.99-29.99%) and the remaining $11,500 is 401k loans which I am locked into paying back at a rate of $55/wk for the next 4 and half years or so.

Minimum payments on my credit card debt are almost $500/month and, because of that, I’m living paycheck to paycheck. Worse than that, actually, I’m only making ends meet by taking on overtime at work. My other expenses are basically just the minimum that I need to get by, though I’ll admit to endulging in $16.99/month for Netflix.

I’m in this mess due to a recent divorce and medical expenses that were covered by the 401k loans, along with some bad spending choices in the past. This was manageable when I was married and had two incomes, but I just can’t keep up with all of this on just my income anymore and I’m not even making a dent in the credit card balances.

I don’t want to just stop paying the credit cards but I don’t know what else I can do at this point. I own no property to speak of outside of a car worth around $2500, and my credit is not the greatest (mostly due to high balances compared to available credit, not late payments or anything), so I doubt I would qualify for any kind of consolidation loan.

I want to go back to school and friends tell me I can get most (if not all) of it paid for through grants and loans, and even get money back to live on (the nature of my work would allow for me to work and go to school full time), which would effectively help me pay off the credit card debt or reduce the interest (or even defer the debt) by effectively converting credit card debt into school loan debt (although I’m told that might be illegal depending upon the loan source).

I guess I’m just looking for ideas or some kind of alternative to just giving up and letting the credit cards go to collections.

I’m afraid of what happens at this point if some major unexpected expense occurs, because I’ll have no way of covering it (half of the credit cards I’m paying on were closed by the banks a while back during the credit crisis, and the other half are still pretty close to maxed out).
- Tony

Student loans are typically awarded with a requirement that the money be used for education related expenses. However, most student loans do include a living stipend which is intended to be used to cover living expenses while focusing on your studies. This does include one’s bills.

If I were you, I wouldn’t go down this route. Instead, I would try to get into college with a student loan in hand, then negotiate with the credit card companies by clearly telling them that you are a student and you do not have the means to pay the bills. See if you can negotiate a settlement of some kind.

You can negotiate with them now, but you’ll have more leverage if you’re in a situation where you can demonstrate that you can’t pay the bills. Right now, you have a history of being able to pay the bills without a change in employment, so you’re less likely to have success by simply calling them up.

If you’ve reached a point where you’re simply going to default on these credit cards, call and negotiate with them.

Q5: Taxes and freelance work
As you probably know, when you earn money from a blog (or from freelance) you typically get it 30-60 days after you actually do the work. For tax purposes, should I account for this income when it’s earned or when it’s received? It seems a bit unfair to make me recognize it immediately when earned because I might never get it, but I can also see how maybe that’s the right thing to do.
- Nick

You are liable for all income received during the tax year. So, if you earned the money on your blog in December 2010, but the check doesn’t arrive until April 2011, you don’t have to file it until your 2011 taxes, which you would file in 2012.

This really is no different than earning a paycheck. If you work the last week of the year, you’re not getting your paycheck for that week (typically) until early in the following year. Many jobs don’t pay you for a pay period until the end of the subsequent one. So, if you start a job with a twice-monthly period on December 16, you won’t have to pay any taxes for that job during that year.

What matters is when you receive payment, not when payment is promised to you.

Q6: Income based repayment
I’m wondering if you know anything about Income Based Repayment (IBR) for federal student loans. Here’s my situation: 28 years old, graduated from medical school in 2009, now in my second year of residency (I’ll be completely done with my training in 2014 or 2015).
Debt:
-$205,000 in student loan debt (I know) from medical school mostly but also undergrad. Interest rates vary, 2-6%. Currently in forbearance.
-$2100 on private student loan, 2.2% interest rate, in repayment, making minimum payments monthly
-$6000 remaining on a $6500 residency application & relocation loan with 5.25% interest, in repayment, making minimum monthly payments.
-$2300 credit card debt – have been aggressively paying this down since I started reading your blog 6 months ago, it’s already down from $7000 and is my top priority

I have $2500 in savings, and am contributing automatically to that every pay period. I have not yet started saving for retirement. I’m wondering if you know anything about the merits of income based repayment, which (as I understand it) allows one to enter repayment on certain loans (about half of my education debt qualifies) and the amount due every month is based on your debt:income ratio. If you continue making payments for 25 years, any remaining debt is forgiven. However, since I can reasonably predict an increase from my current pre-tax salary of $45,000 to $200,000 once I’m done with training, I’m not sure the promise of forgiveness after 25 years is really a draw and thus I’m not sure of the benefits of entering IBR and wonder if I would be better off starting to contribute to retirement, since my student loans will be much easier to manage once my salary is increased and they are at a (relatively) low interest rate. I’m just anxious thinking about what is essentially a mortgage without the house.
- L. C.

Income-based repayment is a program in which your public student loan payments are capped at a reasonable amount based on your current income and family size. Typically, private student loans don’t have such a plan.

I don’t think that, since your loans are in forbearance right now and you’re confidently anticipating a big income spike in the future, IBR will really help you very much. When you get your post-education job and your loans go out of forbearance, your income will be high enough that IBR won’t really be of much assistance to you.

I think you’re thinking of this wrong, though, when you say that you have “a mortgage without the house.” You have an education that’s going to enable you to earn $200,000 a year. Without it, you’re earning $25,000 a year. Two or three years of that will take care of all of that outstanding debt, then you’re riding the financial gravy train to retirement. I’d far rather have $175,000 a year in additional income than a house worth $200,000.

Q7: Handling new annual fee
My husband and I recently noticed a $60 annual fee charge on his credit card. We’re unsure about to do about this, if anything. We don’t use the card much and never carry a balance, but would prefer to keep it because a) it has a high limit and b) we’re young and it’s our oldest credit history. Should we cancel the card and save the $60 a year, or just view that $60 as payment for a better credit score?
- Madeline

It depends on whether you have any other cards that are more than a few years old.

If you have such a card, I would cancel this one that is charging you a fee. The impact on your credit score will be small and that impact will disappear within a year or two.

If you don’t have such a card, I’d apply for one today and just sit on it for a few years. Pay the fees, then drop this lemon of a card in a few years.

Q8: Buy or repair?
Our basics: Roughly 3,000 cash emergency savings, heavily drawn down from what it used to be; about 5,000 in investments that I am hesitant to tap, since I was hoping to build them into an eventual house down payment; I expect to bring in perhaps 3,000-4,000 per month for the next few months, though I’m unsure how long that will last; our monthly expenses can be reasonably brought down to around 1,500 per month, including rent. We have close to 30,000 saved in Roth IRAs, but we haven’t contributed recently due to lack of income; I’m hoping to contribute something out of my next few paychecks to count as 2010 contributions (my husband and I are in our late twenties, so a bit behind schedule but not too bad). My husband has student loans, and will end up taking on more, but graduates of his program tend to either make more than enough to repay their loans or else qualify for loan forgiveness programs through public service, and he’s already ahead of the game since I’m (at least theoretically) able to work to pay our living expenses and he won’t have to take out extra loans to live on (yet). Other than that, we have no debt, credit-card or otherwise. Our credit histories are a bit sparse but very respectable.

(Very) Long story short, we will need a new(er) car eventually. Possibly two. Should we spend the money to fix up our old one? It feels like my decision to donate my car back in March is coming back to haunt me–it was a bit newer, a bit bigger, and somewhat better suited to the weather than my husband’s Avenger. That decision is made, for good or ill, but I’m worried about making the same mistake twice!
- Nicole

Nicole’s email was very long – I did my best to excise it down to a reasonable length.

In your situation, I’d try to keep your current cars running for as long as possible. If you replace them, you’re going to not only be on the hook for a monthly car payment, but you’re also going to be on the hook for higher insurance.

If you’re going into a period where you know that your income will be lower for a while, you do not want to take on required monthly expenses. Instead, I would bank the extra money you’re earning right now into a cash emergency fund in a savings account somewhere. Then, when an actual emergency happens (your car breaks down, etc.), you have the cash on hand to deal with it.

Q9: Paying cash for a car
I wanted to buy a car costing 20k. I already have the cash for it. However, financing for it means extra processing fee (350 cash vs 800 finance). It also means running around town to have the car evaluated, loan application (financing thru my current employer requires specific instruction) and will delay the delivery (car dealer will only release the car after the check from my employer cleared).

Do you think it is a wise decision to pay cash rather than financing it (my employer’s interest rate is very low compared to banks) as it means i have less money (very, very much less) in the bank?

I’m in a good financial situation (I think) as i’m single with about 4 month’s salary for emergency fund. But it will took me about 2 years to save 20k again, if i’m really careful with my money (as new car means additional maintenance expenses) and i do plan to register for postgraduate study part time soon.
- Zid

As long as you’re not reducing your balance in the bank to nothing at all, I would pay cash for the car. Once the car is yours, I would seek to replenish the savings in your savings account as quickly as I could.

Look at it this way. If you take out a loan to do this, you’ll have a monthly car payment. The interest on those car payments will go to some company. On the other hand, if you take the money out of your savings to do this, you’ll still have a monthly payment – it will just go into your savings account. The interest on those payments will go straight into your pocket.

If you’re maintaining an emergency fund of at least $1,000, I would buy the car with cash.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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