In my last post I talked about leveraging 0% APR promotions to invest more money than I would normally be able to.
If I’m able to make so much money off of them, then who loses money and why do they even exist?
0% APR on all purchases for X Months
Credit card companies often offer 0% APR for 12-18 months from opening a new card. This means that you won’t pay any interest on balances for over a year and they won’t make any money off of that interest.
However, they do make money off of interchange fee. Interchange fees are charged to the business in exchange for being able to accept your credit card.
If you are enticed to spend more money because there is no interest charged to you, then the promotion is working by generating more interchange fee revenue for the bank.
Worse yet, a person who takes advantage of a 0% APR promotion and only pays the minimum payment each month is being conditioned to continue to only make the minimum payment long after the promotion expires. This means that the bank will start charging interest and making even more money off of you.
Knowing this, it is important to realize if you are spending more money than you normally would and to either pay off your credit card balance in full each month or have the money available to pay off the credit card in full after a promotional APR expires.
0% APR for X Months with 0-3% fee
If you have a credit card, you’ve probably received an offer in the mail for a balance transfer that costs 0-3% of the transfer amount and then 0% APR for 12-18 months. Interchange fees were described in the last paragraph but there are no interchange fees associated with balance transfers. So, why would a bank offer such a low cost balance transfer?
The bank’s first bit of revenue comes from that fee – 2% of a $5,000 balance transfer is $100 straight into the banks pocket. But then they make $0 dollars for over a year. There is more to it than that.
Similar to the credit card promotions, banks know that someone who is transferring a large balance probably isn’t able to pay it off anytime soon. If a person transfers $5k and they make the minimum payments for the promo period they will have only paid off $600 after a year. This means the bank gets to charge them interest on $4,400 dollars every month until it gets payed off. This can add up to a lot of interest revenue for a bank.
Another reason for these promotional balance transfers has to do with a banks strategy to avoid loss.
Let’s say someone racks up $10,000 in credit card debt that they can’t afford. They are being charged up to and over 25% APR which means 2% of $10K per month. This is $200 every month on top of the $10,000 they already owe. They probably can’t afford that and after a few months of paying over $200 and their $10,000 hardly moving, they might just stop paying.
Banks do not like this. Instead of making revenue off of interest, they end up losing the $10k that they loaned and have to sell it for pennies on the dollar to a debt collection agency.
So, before this happens, the credit card issuing bank or another bank, offers the person a promotional balance transfer. This allows the person to start making interest free payments and get that $10k balance down to by a hundred or two dollars a month. At the end of the promo period the bank starts to make money off of interest again and they avoided a $10k loss from someone defaulting. Everybody wins!… well not really because the person in this example is still in high interest debt.
Don’t allow yourself to fall into these traps and lose money by irresponsibly using credit. Buy only what you would have anyway (if you didn’t have a line of credit) and pay off your statement balance every month.