What's a Balance Transfer?
You
perform a balance transfer by moving high-interest-rate credit card debt to another credit card with a lower interest rate. You usually transfer the complete balances of all your credit cards at the same time. This has certain benefits:
- You reduce your monthly interest charges
- You reduce your monthly minimum payment
- You only have one payment a month to schedule
- You can apply the monthly savings to pay down your credit card debt faster
- You can use balance transfer checks from the card-issuing bank to transfer non-card debt, such as car loans
- You avoid certain payment allocation problems if you don’t make additional purchases on the balance transfer card
However, as we discuss below, you can expect to pay a fee for every transfer.
Payment Allocation
The Credit Card Act of 2009 mandates that credit card issuers allocate payments that exceed your monthly minimum to the highest-interest-rate items first.
Credit cards often have different interest rates for purchases, cash advances, and balance transfers. Therefore, it’s important to reserve the use of your balance transfer card exclusively to, well, balance transfers.
Why is this? As we describe below, your starting interest rate on a balance transfer should be a 0% teaser rate. Therefore, payment amounts above the required minimum will go toward paying down your balance transfer last. And that’s not why you did the balance transfer. Sidestep the confusion by avoiding purchases and cash advances on your balance transfer card.
Repeat Transfers
Some folks try to outsmart the credit card companies by doing balance transfers when the 0% teaser rate expires. The idea is too clever by half. First, you’ll be adding fees with each transfer. However, more importantly, every time you apply for a new credit card, you hurt your credit score. That’s because lenders will see that you’re obtaining new credit while maintaining high debt balances. To them, that marks you as a risky consumer. You might have trouble qualifying for more cards, let alone big ticket loans for a car or a house. Respect the balance transfer and creditors will respect you.
What Rates Should You Expect?
You should always expect a starting, or teaser, APR of 0% on the transfer balance. Most credit cards offer new cardmembers a teaser 0% rate on balance transfers (and often on new purchases) for a set introductory period - usually from 6 to 18 months following the account opening. During the introductory period, all your payments (except for the initial transfer fees) go to paying down your balance - as long as you don’t use the card for purchases or cash advances!
Once the introductory period expires, you’ll face the credit card’s regular rate on balance transfers. That could be 15%, 20%, 30% or more. A lot depends on your credit score. It would be ironic (indeed, sadly ironic) if the new rate exceeded the rates on your old cards before the transfer.
Check a card’s regular rates before committing to a balance transfer. Your goal is to pay down the balance before the introductory period expires. That might mean you look for the card with the longest introductory period, even if it charges high annual or transfer fees.
What Are the Common Balance Transfer Fees?
In general, expect to pay about a 3% fee for balance transfers. This is a one-time fee for each transfer. Astonishingly, a few credit cards waive the balance transfer fee, but they usually have a short introductory period. Unless you plan to pay off the balance quickly, these zero-fee cards might cost you more in interest than you save on fees. You can find calculators on the internet that show you how much you can save through a balance transfer. Remember to include transfer fees if the calculator omits them.
What Should You Do Once Your Balance is Transferred?
From a financial viewpoint, it’s best to do nothing after a balance transfer. By “do nothing,” we mean you should not charge any new credit card debt until you pay off the old. If your introductory period is one year, then you should plan to pay off your debt in no more than 12 monthly installments. Otherwise, you’ll be hit with interest charges on the remaining balance. Consider the introductory period a gift from the credit gods. Use the gift wisely and you can dig yourself out of a debt spiral, embarking on your journey toward a better credit score.
Are There Other Options to Get Rid of Debt?
The main alternative to a balance transfer is a debt consolidation loan. This is a personal loan that provides money you can use to pay off existing debt. Debt consolidation loans usually charge less interest than credit cards do. They do not have the balance transfer card’s 0% introductory rates. Some lenders might waive the loan origination fee, whereas others might charge a fee as high as 8%. Obviously, it pays to shop around.
If you have high credit card debt (say, five figures’ worth), a consolidation loan might be your best bet. That’s because you’ll have longer to pay it off and it will charge less interest than will the balance transfer card after the introductory period expires. The bottom line is that you’ll have smaller monthly payments with the consolidation loan. On the other hand, because the loan has a longer term, you might pay more total interest than you would with a balance transfer. These are tradeoffs for you to carefully consider before committing to a course of action.
You certainly do not want to declare bankruptcy unless you have no other choice. Bankruptcy will stain your credit history for at least seven years, making it extremely difficult to obtain credit. A better idea is to speak with your creditors about a work-out plan to lower your monthly payments. You might be surprised how accommodating creditors can be if you threaten them with bankruptcy. But that’s not a trigger you actually want to pull.
