You're ready to conquer your credit card debt, and the last 0% balance transfer offer you received in the mail looked appealing. However, you need to find out whether the fees involved in the transaction cancel out your interest savings. If you accept a balance transfer offer, you want it to help you toward the goal of paying off your debt - and avoid just shuffling your debt to different cards through a game of credit-card poker with your banks. Read on to find out how. (Managing your debt could mean the difference between spending $45,000 or saving $184,000, read how in Expert Tips For Cutting Credit Card Debt.)
A balance transfer is the process of switching a credit card or loan balance to another credit card. Balance transfer offers you receive in the mail are completed by calling your credit card company and providing it with the amount you would like to transfer and from which credit card or loan; you can get as low as 0% interest charged on the amount.
The credit card company that offers the balance transfer may offer a 0% rate for a limited time, such as six months to a year, or the balance transfer offer could include a fixed interest rate on the balance transfer amount. While some balance transfers are only valid for one balance transfer from one credit card or for one bill or payment to your bank account, many credit card companies will allow you to transfer as many balances as you would like.
Your promotional rate on your transferred balance will generally last six, nine or 12 months. However, this can be tricky if you already have a balance on the card to which you are transferring more debt.
Previous Balance Problem
Suppose that you owe $2,000 on your credit card with a 15% annual percentage rate (APR) before you transfer a balance of $1,000 from your second card. The balance transfer rate you are offered is 0% for six months. You pay off $1,000 in six months, but because the 0% portion of your credit card debt is paid first, you will be charged at the 15% APR rate for six months for the $2,000 that was untouched by payments. Meanwhile, the card you transferred $1,000 from has a rate of 12% APR, representing a loss of 3% for you. You could cost yourself money in interest paid and transfer charges by using a balance transfer offer in these circumstances. The money you lose only multiplies when you transfer more balances if you are doing it at the risk of being charged more interest at a higher rate on the remainder of your credit card balance. (For more insight, see Cut Credit Card Bills By Negotiating A Lower APR.)
Some credit cards give cardholders points for using their cards. This additional perk can be an incentive for cardholders to roll a balance into a rewards card. However, this may not always be beneficial. For example, suppose that you use your credit card every month for your daily expenses and then pay it off in full in order to get airline miles. You never pay interest because you pay the balance within one cycle. You then transfer $1,000 from this card to a six-month card with a 0% interest offer. You won't be charged interest on the $1,000 during the six months, but you will get charged interest on anything else you pay for. This includes what you would have normally paid off without interest by the end of the month. So, in order for you to earn points without interest you will now need to pay off the $1,000 plus whatever you purchased.
Balance Transfer Can Impact Interest
Going above 25% of your maximum credit limit on any of your cards can raise your interest rate on any or all of your credit cards. This is because your credit score is partially based on how close you are to your maximum credit limit. (Avoiding loans completely goes against the norm but it can be possible - and enjoyable. Read Can You Live A Debt-Free Life?)
Consider the following circumstances:
- You have a $10,000 limit with a $1,250 balance. You are using 12.5% of your credit limit.
- You transfer $5,000, creating a total balance of $6,250. You are now using 62.5% of your credit limit.
- This 50% increase in your balance on one card could cause the interest rate to rise on all your cards, because any of the credit card companies handling your accounts can access your credit score.
Most fees range from 3-5% of the amount you are transferring. Occasionally, you can find fee-free balance transfer offers. If you are charged a fee, there is usually a maximum amount the can be charged for the transfer.
For example if your balance transfer fee is 3% to a maximum of $75 and you transfer $5,000 to your card.
- 3% of $5,000 is $150.
- $75 is less than $150.
- $75 is your balance transfer fee.
- $75/$5,000 = 1.5% interest charged.
If your balance transfer offer is good for six months, you save money as long as you pay off your balance within six months and the interest rate you would have been charged on the card you transferred the balance from was above 3% for 12 months.
Beware: If you transfer over a debt and expect to pay it off before the promotional rate ends but fail to do so, the mistake can be very expensive. Similarly, if you default under any of the cardholder agreements, such as by forgetting to make a payment, going over your limit, or bouncing a check, the interest rate can jump to the default rate, which could be as high as 30%.
Balances Worth Transferring
Let's say you have five credit cards, each with a $2,000 balance. Each card has a different interest rate ranging from 8-15% APR. Transferring a balance over to a lower interest rate card is a good idea; even if your balance isn't paid off before the promotional rate expires on the balance transfer, the remainder will be paid off at a lower interest rate. (For more, see Credit, Debit And Charge: Sizing Up The Cards In Your Wallet.)
- Pay off your highest interest rate card first.
While a balance transfer doesn't always make sense because of the fees attached, paying off your highest interest rate card first is always a good strategy. If you have credit cards with interest rates of 17%, 15%, 12%, 11% and 10% APR, pay off the credit card with 17% APR first.
- Negotiate interest rates.
It's free to ask your credit card providers to reduce your interest rates. If you also have credit cards with less-expensive rates, mentioning these may be a good bargaining tool. As long as you maintain a good credit score, you have negotiating power.
Before you shuffle your credit card debt, make sure you're not dealing yourself a hand where you're bluffing yourself into thinking one or more balance transfers will fix your debt problem. Think carefully about all your interest rates, keep fees in mind, and avoid transferring a balance to a card with a higher interest rate. And above all, your end goal needs to be paying off all your debt with an amount in your monthly budget set aside to do so. Otherwise, you may never get rid of your debt, and the lenders will control all the cards in your credit card deck.
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