Wednesday, November 21, 2012

Smoking Crack in Moderation

I'm what most credit card companies would label high risk.  That's why they love to deny me credit even with my stellar payment history.  One of the key risk factors I see is a high revolving (credit card) debt ratio & lots of inquiries on a credit report.  I look like someone desperate for credit and since I'm maxed on on my current cards, I probably don't look like someone they would want to extend credit to. If I were them and I was looking at me judging purely based on my CC report, I would be leery to extend myself additional credit as well.

There's an asian proverb that roughly translates into, "tiny specs of dirt make up the mountain."  It's too easy to overlook several specs here and there, but the small specs add up and it ends up being important.  It's how my parents saved their thousands and how I need to proceed to get out my mess.

In finance, arbitrage is the strategy to take advantage of price differences.  Usually, one would sell a stock at one venue, while simultaneously purchasing that stock elsewhere at a different venue to buy low and sell high.  With the credit cards, it makes sense to migrate as much of the debt as possible to lower interest cards.  Being in the rut that I've been, I gave up on arbitrating to 0-2% interest rate deals as offers dried up.  With a little more wisdom from reddit, I've figured I should still take advantage of the rate differences albeit small.

I've figured that I can take the 25% paid to Kays & OldNavy and move them over to a 20% cards.  It's not that great of a deal, but 5% saved on ~$3200 is $160/yr spent on things other than interest.  The trick is not to incur any balance transfer fees, cash advance fees, etc.

As always, the devil is in the details.  I've opened myself up to a very dangerous game of reopening up old plastic that should not exist.  If straight no-fee balance transfers were possible, it would be a fairly simple proposition, however, BT's are not possible.  Thus what I must do is:
  • Spend regular budget items on the lower interest card instead of cash.
  • Use the extra cash to pay down the higher interest card
So let's say your budget looks like this:
  • $1000 balance @ 20% @ $50/mo ($16/mo interest)
  • $2000 balance @ 10% @ $100/mo ($16/mo interest)
  • $500/mo groceries
On $150 payments, you're spending about $32/mo in interest.

If you could migrate that $1000 balance over to the 10% rate, you'd save $8/mo in interest.  Sure it's not a lot, but it's about $100 bucks.  So without any balance xfer option (try calling the bank first), what do you do?
  • Buy $500 worth of groceries that you would have spent cash on on the %10 card
  • Apply $500 (grocery cash) + $50 (regular monthly payment) to the $1000 balance
  • Make the regular $100/mo payment to the 10% card.
Now you look like this:
  • $450 +interest balance @20% ($7.5/mo interest)
  • 2400 + interest balance @10% ($20/mo interest)
  • 500/mo groceries
So now you've reduced the interest from $32/mo to 27.5/mo.  On the next month, you should be able to pay off the $450 balance with the grocery money and get all the debt into the lower interest rate card.  What's so dangerous about this is that now I've got to start swiping again.  It's like telling myself, a recovering crack addict to smoke new crack in moderation.

In the end it's all about TCO.  For my massive mountain, I'm going to use a hybrid strategy of snowballing debt to free up cash flow, then focus on the highest interest rate items to lower tco.  I suppose it goes against the mantra of keep it simple stupid, but this is simple enough.  Wish me luck.

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