Some Thoughts on Interest-Free Debt

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Karen writes in:

“I have an offer from a credit card company in which they pledge 0% interest for 15 months on a balance transfer. The way they seem to do that balance transfer is that I give them an amount and they send me a check which I then use to pay off a credit card. I don’t carry any other credit card balances so I am thinking about just asking for a check for say $2,000 and then investing it and then paying it back at the end of the fifteen months and just pocket the return. What do you think of that plan?”

I simply wouldn’t do this as you describe it. I would not take out debt to put the money into anything with risk.

For starters, let’s look at the “best” outcome. The next fifteen months continue a stock market juggernaut while nothing bad happens in your life. That $2,000 earns you a $400 return, on which you pay taxes, letting you keep about $300.

Now, let’s look at another outcome: the next fifteen months act like 2008 and you lose 40% of your investment. At the end of those fifteen months, you’re paying back the $1,500, but your investment is only worth $900. You have to come up with the $600 out of pocket.

Several years ago, there were people who were doing this kind of thing but stashing the money in a high interest savings account, back when savings accounts were returning 6%. In that event, it’s not a terrible idea. Under those conditions, the $2,000 over the course of fifteen months would return $150 or so to you before taxes, leaving you with around $100 after taxes. That’s probably worth it.

Today, with interest rates at 1%, you’re looking at a $25 return over that period before taxes, or $20 after taxes. That’s not worth locking down $2,000 over that period.

These assumptions aren’t even including other problems with this situation. One, you’re likely going to have to be making payments on that debt during the interest-free period. Two, organization is a must because you often get hit with some form of penalty for not paying all of it back by the end of the fifteen months. Three, the entire plan rests on nothing bad happening in your life in the interim. Four, it doesn’t include brokerage fees.

In terms of my personal finances, this just doesn’t add up to a worthwhile trade for me. If bank account interest rates were back in the 6% range, we might be looking at a different story, but when you have to take on a lot of risk to have a chance at a return that makes this worthwhile, then it’s not worth it.

Now, if you’re looking at a separate business that you’re trying to run, it might be worth it. As I’ve said before, if I’m running a business, I’m willing to take on some risk as long as there’s a positive balance sheet (with some sizeable breathing room) and a positive cash flow (meaning the business is consistently bringing in more than it’s paying out).

Why is a business different than personal finance? If the business were to fail, I could sell off all of the assets in that business with no impact on the lives of my family in any way. The same is not true when it’s your personal credit or personal property that’s on the line.

(My advice to anyone who wants to start taking more risks with their money is that, if they have their personal finances in a very secure place (no personal debt, a significant emergency fund, retirement savings well in hand) and they have some extra money to play with, starting a company and seeding it with some of that money is a reasonable step. What you do within that company is up to you, but my general advice is what I stated above: keep a positive balance sheet (asset value if you had to sell it right away is higher than the total of the business debt) and make sure the business has a positive cash flow month over month and doesn’t require you to infuse it with more. If you can do that, feel free to take some risks. It’s how many people transition to investing in real estate. If you’re investing in stocks, of course, there’s no need to do this, though you may want to consider it.)

So, when you see a zero percent credit card offer issued to you personally, be careful about it. There’s risk involved and, for most people, the reward doesn’t add up to enough to balance out that risk.

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