4

I can guess the answer to this question, but I can't figure out why. So here goes...

  • I've got an unsecured line of credit with a limit $30,000.
  • The annual interest rate is 6%, compounded daily.
  • Every month, I am required to pay 3% of the balance as a "minimum payment".
  • There are no transaction fees.

What prevents me from paying the "minimum payment" from my savings account, then immediately withdrawing that same amount from the line of credit back into the savings account? The net effect is that I'm not really making a payment, so clearly this can't be possible... I just don't understand how the bank would be able to differentiate between this scenario, and the scenario where I legitimately need to borrow more money shortly after paying the minimum payment.

What am I missing?

UPDATE: I get the importance of paying back loans and limiting what you borrow. This is purely a theoretical question about whether the "minimum payment" requirement has any practical impact, or whether it can be circumvented using this mechanism. It sounds like the bank is putting on a show of encouraging you to pay back the loan, while not actually doing so.

  • You're missing that you'll be paying interest, compounded daily. Also, if you borrow more, your balance will become more, and thus your minimum payment will become more, until you reach your limit. Just don't borrow money or pay it off if you already have it. – BLaZuRE Jan 17 '14 at 6:28
  • Are you sure you can extract the needed money from your credit card? My credit card has high fees for cash withdrawals, and a pretty low limit (much lower than the normal credit limit). – Daniel Lubarov Jan 17 '14 at 6:29
  • @BLaZuRE I get that. Question updated. – Gili Jan 17 '14 at 6:39
  • @Daniel it's not a credit card. It's a personal line of credit. The output is pure cash. – Gili Jan 17 '14 at 6:41
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    I had a bad period early on (30 years back) and did this juggle for nearly two years. It works, and is far better than letting any bill go unpaid. As long as you have an escape plan. – JTP - Apologise to Monica Jan 17 '14 at 17:29
5

This is fine and can definitely be done. The bank will be perfectly fine with it since you're paying interest on the money, as long as they're confident that you can repay the whole (growing) balance. Of course, there's the issue of the credit limit which you'll eventually reach and then you won't be able to pull this off any longer.

Problems start when the bank either loses that confidence, or the credit line is term limited (like HELOC, for example) and comes to term. In either case, you'll be required to cover the balance, and especially in the first case - as a balloon payment. If they call on you when you do that - you will most likely go bankrupt, and the longer you keep doing it - the higher are the chances of that happening.

  • I see. So to reiterate the point then: are you saying that the practical monthly minimum payment is actually $0 in spite of them asking for 3%? – Gili Jan 17 '14 at 7:59
  • @Gili I would read carefully the terms and conditions of the loan, as it may be a prohibited behavior by rules. Technically - it is not exactly zero, as your balance goes up by the interest accrued, so you'll end up paying more in the end, you're just deferring it. – littleadv Jan 17 '14 at 8:25
  • Just called the bank and they confirmed this little loophole does not violate any of their terms. Thanks. – Gili Jan 17 '14 at 16:58
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This is basically the same as any other loan out there that defers payments. The bank doesn't care because your balance with them keeps going up along with their future profits when you pay that balance back. The only point where this becomes a problem for them is when you get to a point where your monthly income no longer supports the minimum payment required.

(BTW, this is basically a study of what the US Treasury is doing with the national debt and the annual budget deficit, but I will go over to politics.stackexchange.com before commenting on the wisdom of this.)

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Back of the envelope calculation:

30K limit, 5 year draw, 5 year post draw payback. Int 6% a year, 3% minimum payment.

Borrow 5K at the start of the draw period, make the minimum payment for the next 5 years. At the end of 5 years still owe approximately $1123, and have paid ~775 in interest.

Borrow 5K at the start of the draw period, make the minimum payment for the next 5 years but borrow the money from the line of credit. At the end of 5 years still owe approximately $6711, and have paid ~1711 in interest.

The bank loves you. The balance grows instead of decreases. That growing balance become pur profit. Of course you are good for it, because you never came anywhere near the maximum limit of 30K.

This is a variation of somebody tapping the line of credit to invest it, then discovering that it is hard to make enough money to make it worthwhile.

Detailed scenario:

  • Starting balance: $5000
  • Minimum payment: $150
  • Interest: $25
  • Post payment balance: $4875
  • amount borrowed to make minimum payment: $150
  • New balance: $5025
  • repeat 59 more times.
  • I think you're wrong on the second case. If I borrow $300 and immediately pay it back to the credit line then I end up with the same balance/interest as I originally had. The only thing that changed is that I paid off the "minimum payment". – Gili Jan 17 '14 at 15:33
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    except you also owe the interest. – mhoran_psprep Jan 17 '14 at 16:49
  • The amount of interest owed remains the same because the resulting balance is identical before/after I borrow money from the credit line to pay itself. – Gili Jan 17 '14 at 16:55
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    Observation - behave as the OP stated, draw $5k, and after 30 days you have accrued $25 interest. Make the payment as OP stated (minimum pmt $150.75, pay it then extract the same amount). You owe $5025(ish). Repeat 59 times. You have paid nothing, have accured interest compounded on $5000 for 5 years. – ChuckCottrill Jan 17 '14 at 17:34

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