I got an interesting reminder this month to keep my eyes open.
From http://www.lowcards.com/2009/01/credit-card-reward-programs-changing.html:
"This month, Chase added a $10 monthly fee and increased the minimum payment from 2 to 5% for cardholders who have carried a large balance for over two years and pay only the minimum each month. "While this minimum payment increase is good for forcing cardholders to pay down their balance, this monthly fee has created an outcry from affected cardholders," says Hardekopf."
It's a good thing that I've started paying attention to the fine print the credit card companies have started sending out. I was one of those who took advantage of Chase's 3.99% balance transfer rate until you pay it off in full. I canceled the card last month when they tried to raise the rate on new purchases. Even though I didn't use that card for anything except the 3.99% balance transfer rate, it was annoying me that they'd raise my rate when I hadn't done anything wrong.
It's a good thing I did, because I'm one of those people who carry a large balance (hey, 3.99% is barely over inflation-- it's lower than my mortgage, so it's going to get paid off last) and make a small payment each month. I would NOT have been happy to see a $10/month fee and increased minimum payment.
Of course, all of my cards are raising their rates now. I guess that's a good thing. It'll encourage me to pay off all my cards (except the one that at a lower interest rate than my mortgage) and stop putting on more than I can pay off in full each month.
I have this bad habit of starting to carry a balance around August each year and not pay it off until I get my tax refund.
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8 comments:
Think twice before dismissing a rate as lower than your mortgage, since your mortgage is tax-deductible. Basically tack on 30-50% to the credit card rate to make the comparison with your mortgage fair. (50% would correspond roughly to a 33% tax rate). OTOH it's late enough I shouldn't probably be trying to do math and blogger.com doesn't support Google goggles.
Jeff, fair enough. Here's a better apples-to-apples comparison. The rate on that card is about 2% lower than my car loan (which isn't tax deductible either).
Even if I tack on an extra 30% for taxes, it still makes sense to pay this card off last. Between mortgage deductions and my 401K, my actual tax rate isn't anything close to 33%.
The only thing that would hurt me would be if I somehow missed a payment and forfeited the low rate.
If your tax rate is 25%, you should be adding 33% to your credit card rate, since you're inverting it. Definitely pay off the car first, but the mortgage might not be worth knocking out before the credit card.
According to TurboTax, my effective tax rate for 2008 was 13.93% (after 401k, my flex spending account, and other deductions). I'll definitely pay off the car first and then re-evaluate.
What does "since you're inverting it" mean? I'll be the first person to admit that I don't know enough to crunch the numbers myself in many cases...
While your effective rate is 13.93%, you should be going by the rate on the last dollar you paid taxes on, since those are the dollars that wouldn't be getting taxed. If your effective rate is 13.93% I'm going to guess your top rate is 25%.
In other words, for every dollar that would no longer be taxed since it's paying off your mortgage, you'd be saving 25 cents in taxes.
The reason you "invert" numbers is because percentages are higher going up than they are coming down.
If you have $100 and lose $25, you've lost 25%. To earn back that $25, however, your money would have to gain 33% on what you have right now ($75).
In your example (and I feel like I'm doing something backwards, so ask anyone to correct me), if you were going to decide where to pay off $100 extra of your debt, you'd have to consider not only what you already were:
$100 x 4% = $4 in interest savings
$100 x 5.5% = $5.50 in interest savings
but also that by paying off the mortgage, you're not getting to deduct that interest paid from your taxes. If you'd pay off the credit card, you'd also be saving 25% of the interest you are not paying on the mortgage, or $5.50/4 = $1.375.
[In retrospect, I'm not sure why you'd invert the number; you're actually calculating based off the mortgage, so you stick with the true %.]
In the end, you're probably still better off paying the mortgage off, but because of the taxes, it's a lot closer than you'd think - a net difference of just .125%, not 1.5%.
I'm not 100% sure that I followed that, but I'll take your word for it for now and try to break it down when I'm more alert.
But if I'd only be saving .125% by paying off the mortgage first, I might as well just pay the card off. It'd make my mother happy. She believes that "credit card interest will eat you alive" no matter how low the rate. I think she'd say that even if the interest rate was less than inflation!!!
If it's actually that close, you might be better off knocking out the credit card anyway. Utilizing such a low percentage of [or none of] your available credit, consistently paying your mortgage, etc. might raise your credit rating and let you refinance your mortgage or something of the sort at a lower rate than what you're currently paying at some point in the future. Or, if you decide to buy a car or move to a new house, it might make it that much easier.
Ezzie,
Those are all good points. I'm not sure that freeing up the additional credit would affect my score all that much though, since I'm using about 20% of my available credit. I don't think your credit card is affected until you've used up a third (or more) of your available credit. Of course, I could always be wrong.
But right now "Make Mom happy" sounds like the tipping point in favor of paying debt off in the order of car, credit card, mortgage anyway. The idea that I might increase my credit score is just a little extra icing.
It's strange, somehow paying down the car doesn't feel as good as paying down the high interest credit cards did. I need to figure out why that is and what I can do to increase my motivation to keep being careful and paying down the debt.
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