I received a message from reader Mike last night asking for thoughts on reducing the cost of his $16,000 personal loan, currently running at 10% APR. Mike has a credit score of 725 and told me that he could afford a $500 monthly payment on a very secure salary. One of the things that looked attractive to him was the possibility of using an Auto Loan since they have some of the lowest APRs of any loan, currently you get a rate of 1.99% APR for either new or used Automobiles through PenFed.
Clearly paying 2% rather than 10% is a more attractive proposition, lets look at the numbers quickly and see just how good it is. Mike did not tell me how much he was currently paying per month, but I am going to $500 payment, as when I asked him what his Max was he gave me this number. When deciding upon the Max you can pay you should take into consideration these factors:
- Emergency Fund size
- Job Stability
- Tax Advantaged Account Contributions
Once those are addressed, you should throw as much money as you can into paying down the loan, so you can get clear of the debt. For more on the Math behind the question of Paying Down Debt Vs Saving see this post.
Impact of Interest Rate on Debt
It’s a no brainer that lower interest = a better loan, so I won’t bore you with charts, just a quick recap of impact for the $16K loan at $500 per month.
- Current Rate 10% = 38 months of $500 (final month $5.96) ($18.5K total)
- Possible Rate 1.99% = 33 months of $500 (final month $425) ($16.4K total)
Purpose of Loan Rules
The bad news for Mike is that an Auto loan cannot directly be used for anything other than an Automobile, it is a specific loan for a specific purpose, and the loan provider will expect some sort of proof that it is auto related, such as the title of the car. However, there is one loophole here in regards to using an Auto Loan for personal use.
The Cash Out Refinance of an existing automobile.
Many credit unions will lend on the asset that is your existing vehicle. This is an excellent way to generate low interest loans that could then be applied to paying down other debt. I have heard stories of PenFed and other Credit Unions offering above book value on a vehicle, which is a phenomenal deal. Check out a conversation about this here from the BogleHeads. As such, if Mike does already own a car he could reduce his Interest payments by $2000 by using this tactic.
Option 2 – Refinancing from Home Equity
Home Equity Loans and Lines of Credit are great ways to refinance. They offer two positive things for people with Personal loans or Credit Card debt:
- Considerably lower APRs than Personal Debt, PenFed has Home Equity Loans from 2.74% and major banks will offer these from about 3-4% upwards at this time.
- Interest on Home Equity borrowing is Tax Deductible if you Itemize your Taxes. This means you get an extra saving on what you are paying out.
Needless to say, you need to be a home owner, and furthermore must have sufficient equity in the home to be able to finance in this manner, for those that are not, here are some more options to lower the cost of your loan.
Option 3 – Swapping for a Like for Like Loan at a lower APR
If you are not a home owner, then this is also a logical consideration., just search around for alternative Personal Loans and see if you can get a better rate. It is worth checking two things when doing so, and whilst this rarely happens it is good to ask and factor in: does they existing loan have an early payment penalty, and likewise does the new loan come with an upfront origination fee? Any additional costs to finance should be considered. Unfortunately for Mike Personal Loans are typcially quite expensive, so he might not find a better deal, though Citibank is currently offering a rate range from 6,74% at the low end, to almost 20% on the high end.
If you are considering like for like the best place to find good rates is often Credit Unions, don’t ignore these places, and make sure you pop into your local one to ask in person, you will be surprised at their rates.
Option 4 High Risk Play – Use Credit Cards to buffer debt and attack Principle
Making a balance transfer to a 0% Credit Card offer, they issue Checks so it doesn’t need to be Credit Card to Credit Card transfers, you could put the loan on a card.
This one is risky, because you get a 12 month window to beat your debt down, by using a card such as the and then it rises up in APR to standard rates. At which time you will need to refinance it again, but in the interim you can make a serious dent in your debt. The risk of this strategy is not to be understated:
- You will need refinance again in 12 months, which is likely to be available in the form of another 0% APR offer, but there is no guarantee that you would be able to find an offer at that time, and therefore you may need to take out a fresh Personal Loan.
The rewards are great:
- By freezing APR at 0% for 12 months all of your payments go towards Principle, so you will drastically reduce the value of your loan, even if you then need to create a new Personal Loan you will be well ahead of the game.
The Catch
- Most Cards that appear to offer a 0% Balance Transfer hit you with a Balance Transfer Fee – the sneaky buggers often put that in a separate line from the Balance Transfer APR so the casual reader will think it is free. The standard rate of this fee is 3%-4% of the total transfer, which actually would still be value, but if we can find a no fee, no interest card then that is striking gold.
Striking Gold
The Chase Slate Credit Card is not an affiliate link of mine, it is not an affiliate of anyone that I know of, which is why nobody talks about it… but it is a superb card for this: If you transfer a balance to this card in the first 60 days they waive the standard 3% transfer fee, and they then offer 15 months of 0% Interest.
In that time, if you were to continue to make Principle Payments of $500 per month, you could reduce your debt from $16,000 to $10,000 without paying a dime in Interest. That is when you would have to refinance again.
Caveats
Assuming you opted to push the balance onto another card at the $10,000 point, you would have to stump up the 3% fee on the $10,000 in order to extend the free loan period. By maintaining the $500 payment rate you need another 20 months of Interest Free loan period to pay off the card in full. A great option for this would be the Citi Simplicity Card which offers 18 months Interest Free (but comes with 3% initiation fee). Also, if you had a significant other it is perfectly viable that they open a second Slate card, and you avoid the 3% fee for the Simplicity card, and get a second 15 months of free credit (should the offer be available at that time).
Checks aren’t available on demand.
I just called Chase to confirm, but the Balance Transfer checks are not available by request, they are issued by Marketing. The are typically issued at the start of a new card relationship, but if for some reason they are not then a work around solution (that actually makes a profit) would be to apply for two cards in tandem, along with the Slate also apply for the Barclaycard Ring – this is an affiliate of mine and offers 1% Statement Credit for transfers!
Thats right, zero fee to transfer, and they pay you 1% to bring your money over- the catch is that it is not interest free, so you need to put the loan on the card, then once it is on there switch it off to the Slate immediately for no fee, capturing 1% in the process, up to $160 if you could get a big enough credit line.
I called Barclaycard and they told me that they can do a direct wire deposit to your checking account, or send Checks to you on demand, so whilst it is an extra hoop to jump through it gets your balance on a card, and they pay you for the privilege.
A Note on Behavioral Finance
If you play high risk games like the Credit Card option be aware that a part of your mind will likely try to convince you that since you have interest free money you can ‘enjoy life again’ in other words you let the debt stagnate and do not pay it down. Should you decide to play high risk, high reward strategies to eliminate debt you must remain focused to the goal of eradicating your debt, and making payments quickly.
Wrong Goal – I want to reduce APR
Right Goal – I want to be Debt Free, and by being smart I can reduce the amount of interest I pay on that journey
Note that a lot of credit card offers these days give you 0% on purchases for the first x months–this option can be used as a fee-free BT where you just make your usual credit card purchases but only pay the minimum payment for the promo period. You can then use the freed-up cash to pay down the principal on a loan. Obviously, this carries the same sort of risks as the BT scenario.
So, one caveat I would add is this (and it comes from experience) – once you make a balance transfer to the card (e.g. Chase Slate), Don’t spend another dime on it. Put it in a safe, freeze it in ice, do whatever you need to not to use it. Otherwise you could incur unwanted interest charges as you no longer get the 20+ days of interest free charging b/w charge date and statement closing date.
Great point Trevor – NEVER use the card that has a balance transfer on it, they will stick you for the interest.
Manufacture a 0% loan by paying off last month’s CC bill with this month’s manufactured spend. Requires enough credit line to cover but this is what I do. I have a 4% HELOC but figured why pay 4% interest when I can pay 0% and get the best of both worlds from manufactured spend?
Great stuff! Takes a little skill and plenty of discipline but the benefits are huge if you do this. Thanks for stopping by, I appreciate your comment.
This was easier when Chase was handing out a free $2.5K loan every month on my 4 Chase cards. Still, I do at least 30K of MS each month. Of course, this is very risky without a HELOC to cover since MS options may die and money could get tied up with FR, adverse action, etc.