Question

Choosing a Source of Credit: The Costs of Credit Alternatives

Jamie Lee Jackson, age 27, full-time student and part-time bakery employee, is busy setting up her new home. Her budget is a little tight now as she made the decision to move in to a place of her own, which gives her privacy and independence, but all of the expenses are now her responsibility.

Jamie Lee applied for three store credit cards when she was shopping for her furnishings. The excitement of making selections and the attractiveness of percentages off her purchases made the credit card offers too good to pass up. It was all too easy to select the new furnishings when the cash was not immediately coming from her pocket. “The payments will not be due for at least 45 days from now, by the time all the accounts are opened and the grace periods are factored in. I am sure I will have enough to cover the balances by then,” Jamie Lee convinced herself.

Jamie Lee’s new furnishings have been delivered, and she is quite happy with her choices. The bungalow is comfortable, and Jamie is now getting into a routine balancing the new move with work and school obligations. Unfortunately, the bills have begun to arrive in Jamie Lee’s mailbox; payments are soon due for all the new furniture and appliances.

The corresponding annual interest rates on the credit card purchases were not something Jamie Lee factored in when she applied for the store credit cards. “Wow, 18.5 percent on one, and the other two have interest rates of 19 percent per year. Those interest fees can really add up quickly. The disclosure said that by making the minimum payments, I could be paid off in 14 years! I am not sure my appliances will still be working at that time, nor will the furniture still be in style 14 years from now.” Jamie Lee was starting to feel the consequences of overspending and knew she must develop a plan to pay off the purchases quickly!

Assets: Checking account: $1,800 Savings account: $7,200 Emergency fund savings account: $2,700 IRA balance: $410 Car: $2,800

Liabilities: Student loan balance: $10,800(Jamie is still a full-time student, so no payments are required on the loan until after graduation) Credit card balance: $4,250(total of the three store credit cards)

Income: Gross Monthly salary from the bakery: $2,750(Net Income: $2,175)

Monthly Expenses: Rent: $350 Utilities: $70 Food: $125 Gas/maintenance: $130 Credit card payment: $0

Questions

1. Jamie Lee received an offer to transfer the balance of all her store credit cards to her bank credit card in the mail. It offered zero percent finance charges/interest for the first three months(90 days), and 18.5 percent interest rate thereafter until the balance is paid in full. Upon reading the fine print, there was a $50 transaction fee and interest accrued from the day the balance transfer was made if the balance is paid in full within the first 90 days. How could Jamie Lee use this balance transfer offer to her advantage? How is this offer a major disadvantage to Jamie Lee?

Answer 1

Jenni Lee has a monthly savings scope of = (Net income from bakery (2175) - Rent (350) - Utilities (70) - Food (125) - Gas (130) = $1500.

Currently, the rate of interest on credit card payment default is very huge - 18.5 to 19% and hence she should first use the balance from her checking and savings account to pay off the credit card dues of $4250. This is because the rate of savings is not more than the rate of interest which will be needed to pay on outstanding credit card balance.

She has a total current liquidity of $1800 + $7200 = $9000. Out of this if she [ays her credit card bill hse is still left with $ 4750.

The advanctages of this step will be that she will end up not paying huge amount of interest and penalty on outstandign credit card dues. Secondly it will not affect her credit rating in future.

The disadvantage is that she will have to compromise with her savings account balance.