Balance Transfer Credit Cards
How Transferring Your Debt May Help You Meet Your Financial Goals
If you have substantial credit card debt, transferring your balance to a different, lower-interest credit card may reduce your total debt. Before you leap into this deal, however, you’ll need to do some math to make sure this will actually save you money. While the up-front offer of a zero percent interest rate sounds like an obvious way to cut your debt, most companies charge a 3-5% transfer fee on your total balance. This fee should be included in your calculations when you consider a credit card offer.
How Much Money Could A Balance Transfer Save You?
3-4% doesn’t sound like a lot, but that amount of difference in your interest rate can really add up. If you seldom carry a balance on your card, you may not pay much attention to your interest rate, or realize the impact that it can have when you ARE carrying a balance. The following is an example to illustrate how much total interest you will pay at two different rates, but with the same payment. We’ll use a $5,000 credit card balance and a payment of $109 per month.
With a monthly payment of $109, an interest rate of 18% APR will cost you about $3,529 over the cost of your initial balance. In contrast, a 14% APR will cost you around $2,199. That’s a savings of $1,330, just by lowering the interest rate by 4%. But, if the balance transfer fee is just about as much as your total savings, the process won’t save you any money.
Credit Card Balance Transfers: The Pros
If carefully considered and done correctly, a credit card balance transfer can help you accomplish a variety of financial goals. These include:
SAVE MONEY ON INTEREST
The first and best reason to think about transferring your balance is to pay less in interest. A higher rate means that you spend more money as you work to pay off your debt. A lower rate means you spend less. To find out exactly how much difference a lower rate can make, use an interest cost calculator.
Having multiple due dates for your credit cards, utility bills, and other expenses can be confusing and stressful. Fortunately, combining all of your credit card payments by putting them onto one card can streamline the whole process of paying bills.
With all of your credit card debt in one place, you’ll be less likely to forget when a credit card payment is due. Your total credit card debt will appear on a single statement, making your progress easier to track, and can help promote better household debt management.
PAY OFF OTHER DEBTS
Some credit cards offering balance transfers will allow you to move other kinds of debt, as well. These other forms of debt—such as student, auto, appliances, and furniture loans—often have higher interest rates than the one the credit card is offering. Moving everything possible to a lower interest rate will save you even more money. But make sure you do your homework—some card issuers don’t allow all forms of balance transfers. Check the fine print to see if your goals align with the terms of the credit card offer before making any decisions.
An “unsecured loan” means that there is no collateral offered to guarantee repayment. Most consumer credit card accounts fall under this classification, which means that a credit card company can’t come to your house and repossess any of your household items. A secured loan, such as an auto loan, entitles the loan holder to repossess the collateral (in this case, the car) in order to repay the debt.
If you can move “secured loans” like these onto a credit card—with a low or zero interest rate offer—the car loan is paid in full. Now you owe the balance to the credit card company, which can’t as easily come for your car if you default on your payments.
IMPROVE YOUR CREDIT SCORE
Your overall credit score will improve faster when you consolidate your debt and display consistent repayment behavior. Moreover, by keeping your old accounts open after you’ve transferred the balance, those accounts will now be in good standing. Keep your old accounts open so that you don’t lose any credit age, and keep working to pay down your overall debt if you want to give your credit score a boost.
4 Key Things to Consider Before a Balance Transfer
1. PROMOTIONAL VS. LONG-TERM RATE
To entice you into choosing their card over another, credit card companies will offer low, sometimes even zero percent, interest rates on balance transfers. But they’re not doing this out of kindness; eventually, they want to make some money. So this super-low rate won’t last forever. After the promotional (or introductory) rate expires, the long-term rate kicks in. Always view the interest rate on an offer as twofold, and factor in the long-term costs of the higher rate before making a decision.
The enticingly low rate is only short term, typically lasting no longer than 18 months. The legally-mandated minimum it can last is six months. After this 6- to 18-month promotional period expires, the interest rate you pay is the higher, long-term rate. This could be the same, or even more than your current credit card interest. So pay close attention to the fine print before accepting any offers.
2. FEE FOR TRANSFERRING BALANCE
Many credit card companies charge a fee for a balance transfer to their credit card. This fee is either a flat rate dollar amount or a percentage of the balance that you want to transfer—whichever is higher. The average fee is 3%, according to the Federal Reserve. In our $5,000 balance example, a 3% transfer fee will cost you $150 up front. Make sure to add the balance transfer fee into your cost calculations to see which credit card offers will actually save you money.
Many credit cards that offer balance transfers also offer reward programs or other promotions. If you have good reason to think you can pay your balance off pretty quickly, you can keep the card and use it to rack up some sweet bonuses. By using the card for ongoing spending, you can earn points that you can use for dining, travel, hotels, gas stations, and retail. Most cards also offer cash back rewards that give you a certain percent of your spending as a payout.
If you are on the verge of defaulting on a secured loan, such as your car, you may need to consider turnaround time on your current credit offers. For new customers of a credit company, the approval process could take up to three weeks to complete; for existing customers, it may only take one week.
If you think you’ll be unable to make the next payment on your secured loan, you want first and foremost to avoid defaulting and having your car repossessed. This means that you might need to choose the company you already do business with, such as your existing bank or credit union, because they’ll be able to complete the process faster. Even if the interest rate is ultimately higher than another credit card option, if time is a pressing factor, you may wish to choose the speedier option.
Expert Q&A: Common Balance Transfer Questions
What mistakes do borrowers make when transferring balances?
A: Not considering the pros and cons. All balance transfer offers are designed to look appealing, but not all of them are as good as they look. Some could leave you in a worse position if you aren’t careful. Be sure to make significant payments during the low- or zero-interest introductory period, so that you don’t end up with a higher balance than you started with once the higher rate comes into effect. Always factor in the balance transfer fee. The typical 3% rate will cost you $300 on a $10,000 balance.
Ask yourself some serious questions when considering a balance transfer. Are you simply delaying the inevitable, or will you actually gain ground on this debt thanks to the new offer? Will it actually work out in your favor, or will you just be paying the credit card company more money? Will the zero-interest period allow you to make enough payments to eliminate the balance before the higher rate kicks back in?
What pitfalls should I watch out for?
A: The number one pitfall is that if you miss one payment, that introductory rate disappears. You’ll go back to the regular interest rate for the entire balance. You’ll want to make sure which rate new purchases fall under, as well. Sometimes they fall under the promotional period rates, and sometimes they don’t. Credit card companies are competing to be the one getting money from the interest rate on your balance. They’re betting against you paying off the balance before the low-rate period ends. If you don’t eliminate your balance before then, the higher rate kicks in on your remaining debt, and they start making money.
How much of a hit will my credit score take with a balance transfer?
A: the typical hit will be from 10-30 points. You’ll need to have good credit before you even attempt a balance transfer, so that it won’t affect you very much. Card issuers don’t offer favorable transfer deals to those with poor credit, so keep that in mind when looking through their offers. The credit inquiry will ding your score a bit, as will closing out your old credit card once the transfer is complete.
When is a balance transfer a bad idea?
A: When you don’t have a solid plan for paying off the balance. The low introductory rate is an opportunity to make a real dent in your balance. If you’re still making the minimum payments or barely anything over that, you’re just pushing the problem down the road. Once that promotional rate period ends, you’ll be searching for another balance transfer offer.
This serial balance transfer then becomes a habitual behavior that never addresses the problem or eliminates the debt. Keep in mind that every transfer will incur at least a 3% fee, and missing a payment will slap you with the non-introductory rate. If you’re simply feeding a credit card habit, constant balance transfers are an expensive way to do it.
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