Introductory rates and balance transfers
About this video
Sal explains introductory 0% APR offers for transferring a credit card balance. Card companies offer them because they expect many people to keep a balance after the intro period and pay a high APR, and they also charge a balance transfer fee. He shows how to compare offers and why 20% APR compounded daily costs about 22% over a year.
You'll be able to
- explain why card companies offer 0% introductory APRs on balance transfers.
- include the balance transfer fee when comparing transfer offers.
- choose a transfer offer based on how long I realistically need to pay off the balance.
- explain why an APR compounded daily costs more than the APR itself over a year.
Key words
- Introductory APR
- A low or 0% interest rate offered for a set time, such as 6 or 12 months, when you open or move to a card.
- Balance transfer
- Moving what you owe from one credit card to another.
- Balance transfer fee
- A charge, often a percentage of the amount moved, that is added to the balance you owe.
- Compounded daily
- Interest is added every day, and the next day's interest is charged on that new, larger amount.
Transcript
- [Instructor] So it's pretty common to get offers from credit card companies to transfer your balance from other credit cards in order to get really low interest for a certain amount of time. That's usually given as an introductory APR, annual percentage rate.
It might be tempting. So for example, let's say that right now, let's call this credit card one. You have a thousand dollars balanced right over there and let's say that you are paying a 20% APR and then you get these offers from credit cards A and B that say, hey, if you transfer into us, credit card A is saying for six months, you don't have to pay any interest.
Credit card B says something even better, for 12 months, you don't have to pay any interest. Well, this could be very tempting to you because you're like, wow, I'd much rather for six or 12 months pay no interest than paying a 20% annual percentage rate, which is, by the way, compounded daily.
So over the course of a year, if you hold it there, it actually ends up becoming much more than 20% of your money. But you have to be careful here. The first question you have to ask is, why would another credit card company do this? Why would credit card A or credit card B offer you 0% interest?
Well, what they're hoping is, for example, credit card A, they're hoping that if you transfer your balance into credit card A, that yes for six months, you won't pay interest and they're gonna take a little bit of a hit on that. It actually costs them something to essentially lend you that money and not get any interest on it.
But they are likely hoping or expecting, they do all of these actuarial tables and look at the statistics of it, that most people are gonna keep their money more than six months, and then they're going to pay this 22% APR, and even if you just transfer it and pay it off, there usually is, and they don't advertise this part, there usually is a balance transfer fee as well, which gets added to the balance that you owe.
Similarly, that's what credit card B is hoping. They're giving it for 12 months and they're even giving a better APR than you have, but they have a larger balance transfer fee. So what you need to think about, well first of all, you should make sure you have all of this information and go into this with eyes wide open.
For example, if you feel very confident that you will pay this off, pay off in six months, then the offer that credit card A is giving is actually a pretty good offer because you could transfer that money right now. Yes, you will pay that 3%, which is $30, but that's going to be a lot less than the amount of interest you would pay in credit card one, that 20% APR, and then you would pay it off, so you'll never have to pay any more interest other than that balance transfer fee, so that could make sense.
If you say, hey, and you'll never have to pay this 22% APR. If you think it might take you a little bit longer to pay it off, say 12 months, then maybe credit card B looks good. Yes, they do have a higher balance transfer fee that's $50, but you have more time to get that 0% interest, and even if it goes longer than that, if it takes you 13, 14 months or you don't end up paying it off, you still actually have a better interest rate in the long run.
So the important thing is to do the math. Think about what scenarios are likely to happen for you and just think about and then calculate what you are likely to have to pay. Many people think that if you have a thousand dollars balance and you were to hold it for a year with a 20% APR, that then at the end of that, you would owe 1.2 times that, which would be $1,200.
It turns out that this is just a very rough approximation. The way the credit card companies calculate it would actually be a thousand dollars times the daily compound rate. So the daily compound rate is going to be 1 plus 0.2 divided by 365. This is how much you're compounding each day, and you're going to do that 365 times.
You're gonna do that to the 365th power. 0.2 divided by 365. That's equal to that. You add one to that, that's your daily compounding rate or how much you're growing every day, and then take that to the 365th power gets you to 1.22. So it's actually this turns into roughly a 22% on your money.
So this is actually going to be a little bit more, this is going to be this $1,220. So it's a little bit more than you expected.
Video © Khan Academy, used under CC BY-NC-SA. Watch on Khan Academy. Puzzicle is not affiliated with Khan Academy.