How to make paying off debt pay

By SmartMoney

When you're buried in debt, choosing a credit card is typically a question of finding the one with the lowest interest rate -- not one that has a rewards program. After all, a 1% cash-back bonus isn't much of a perk when you're paying 18% or more in annual interest.

Now some credit card companies, including Discover and Bank of America, are trying to convince you otherwise by launching credit cards that offer special cash-back rewards meant to appeal to those carrying a balance. The goal, they say, is to help folks manage their debt better.

"We found 85% of (consumers who carry a balance) prefer rewards for paying on time versus rewards on spending," says Margo Georgialis, the chief marketing officer for Discover. "So we created a program that combined both. It wasn't just about rewards, but about a total experience of being on top of your credit."

Discover's Motiva card, launched this month, offers a twice-a-year cash-back bonus equal to your interest charges for one month, provided you make payments on time for six months in a row. Bank of America's Money Return Visa, on the other hand, gives revolvers a 10% rebate on the interest charges they've paid for the past year. Both cards feature low-rate promotional periods -- 3.9% until 2010 and 0% for six months, respectively -- on balance transfers and no balance-transfer fees, making it easier for consumers to make a dent in their debt.

How the math works out

But do these new cards stand up to the no-frills low-rate cards or attractive 0% APR (annual percentage rate) balance-transfer offers that revolvers typically favor? It all boils down to the math, says Scott Bilker, the founder of DebtSmart.com.

With Bilker's help, we ran debt payoff scenarios for the two new cards, comparing them with two "old-school" credit cards that also target revolvers, but by using low rates rather than special rewards. The Simmons First Visa Platinum card is currently the lowest-rate card out there, according to Cardratings.com, with a 7.25% fixed APR. And with a promotional offer of 0% APR for the life of the balance, as long as you make two purchases a month (use code F1K7), Citibank's Diamond Preferred Card is one of the best balance-transfer deals around, as long as you approach it smartly. (For details on each offer, see the table below.)

For each scenario, we assumed we'd open a new card and transfer a $5,000 balance. We'd also make $200 monthly payments until the balance was paid off. Except for the Citibank card, we would make no new purchases.

The results were mixed. The 0% APR for life from Citibank came out on top, assuming we made two $1.50 purchases for a total of $3 each month -- think two cups of coffee or two packs of gum -- to keep costs in check. But it's also the offer that requires the most vigilance.

The 3.9% introductory APR on balance transfers through 2010 from the Discover Motiva card scored second. (It's worth noting, though, that in our scenario the $5,000 balance would be paid off before the 3.9% promotion expired. If you could not pay off your debt within three years, you'd be hit with the card's regular APR, now 10.99% to 17.99%, which would increase your total interest charges.)

In third place was the Simmons First card, and the Bank of America Money Return card came in last.

Here are the details:

Credit card	APR on balance transfers	Balance transfer fee	Rewards on finance charges	Months to pay off $5,000 debt	Total interest paid*
Citi Diamond Preferred	0% APR for life, with two purchases a month	3% of transferred balance, up to $75	No special rewards on interest charges (ThankYou points for purchases)	26	$15, assuming you make two $1.50 purchases a month
Discover Motiva	3.9% fixed until 2010; after that, 10.99% to 17.99%, variable, depending on your creditworthiness	None	After every six straight on-time payments, you'll get a cash-back bonus that equals the interest charges on the next statement	27	$190, factoring in four cash-back bonuses averaging $9**
Simmons First Card	7.25% fixed	None	No rewards program	28	$440
Bank of America Money Return Visa	0% for the first six months; after that 14.24% variable	None	At the end of each year, you get back 10% of the interest you've paid	28	$490, assuming two cash-back bonuses totaling $50

* Total interest amounts are estimates for the two credit cards that offer special rebates on interest charges.

** The rebate will vary depending on your actual interest charges. We used an average amount based on the total interest paid over the life of the balance, divided by the months it will take to pay it off.

Mind the details

Needless to say, the offers above come with some notable loopholes. Here are three to watch for:

• Default rates. Promotional offers don't last unless you're at your perfect credit card behavior. These days, a credit card company can jack up your rate to its so-called default rate -- as high as 30% or more -- as soon as you're late with a payment or exceed your credit limit. And thanks to a practice called universal default, you can be slammed with a default rate even if you do that with another credit card or your credit score drops for whatever other reason. (For more, read "Credit card companies' evil tricks.") "With these offers, the credit-card companies are just betting that consumers will mess up," Bilker says. "And many of them will."
• The fine print. Before you take advantage of any promotion -- especially if it's 0% APR for life -- read the fine print. With Citibank's offer, make sure there isn't a minimum amount required for each of the two monthly purchases you have to make to keep the 0% for life, Bilker says. "Call them up and ask them point-blank, 'Can I charge $1.50 twice?'" If there's a requirement of, say, $50 for each purchase, you would end up paying a lot more in interest than the $15 we got assuming a $3 monthly charge.
• Interest on purchases. When you do a low-rate transfer, keep in mind that credit cards apply payments toward the lowest-rate balance you carry. So if you charge new purchases that carry the card's regular APR (often 15% or more), your payments will go toward the low-rate balance, while the high interest on new purchases will pile up. Be sure to retire the credit card as soon as your balance transfer goes through. (For more on this, click here.)

This article was reported and written by Aleksandra Todorova for SmartMoney.

Published April 18, 2007