Balance Transfer Credit Cards
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Credit cards can be used to pay for goods and services. However, they can also be used to pay off other credit cards. These are known as balance transfers – and some credit cards are basically made for this specific purpose. Let’s take a look at how balance transfer credit cards work and how they can save you money, if you use them properly.
What is a balance transfer?
A balance transfer is the act of paying off one credit card with another credit card. The credit card debt still remains, but the balance is shifted between cards. The old card will then have a balance of zero while the new card will take on the old card’s previous balance.
What is a balance transfer credit card?
Credit card issuers are constantly trying to attract new business. One way they do this is by trying to entice people who have credit card debt with another lender to switch over and use their cards instead. In order to make the switch worthwhile, a credit card issuer may release a credit card with a promotional balance transfer offer (e.g. 0% for 180 days). These offers are usually only available for a limited time but are designed to get people to move their balances over, then hopefully remain as customers even after the promotional period has expired.
Why do a balance transfer?
The number one reason people consider a balance transfer is when they have credit card debt on one card and a very low interest rate is offered if it’s transferred to another card. As this low, introductory interest rate is only offered for a short period of time – usually 6 to 12 months – balance transfers make the most sense when you can aggressively pay down your debt during the promotional period.
Imagine you have a $3,000.00 balance with an annual interest rate of 19.99% with Credit Card Issuer A. Credit Card Issuer B offers you 0.00% interest on your balance for a full year, if you transfer the balance to their card. In effect, by doing the transfer, you would avoid interest charges for a full year on your prior balance.
In fact, completing a balance transfer to Credit Card Issuer B would save you $599.70 in interest in the first year.
|Balance||Interest @ 19.99%||Interest @ 0.00%||Difference|
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What to consider before you do a balance transfer
While a balance transfer can save you money, it doesn’t always work out that way. This is because:
- Balance transfers include fees
- Interest rates increase after the promotional period is up (or if you miss any payments)
- If you make any purchases with your balance transfer credit card before you pay off the original amount you transferred over, you’ll be charged interest on them
Balance transfer fees
Credit card issuers will usually charge a balance transfer fee, typically in the 1.00-5.00% range of the amount you transfer over. Say you are transferring $10,000.00 from your old credit card to your new balance transfer credit card and the issuer charges a 1.00% balance transfer fee; that means your new balance will be $10,000.00 + $100.00 ($10,000.00 x 1.00%). Depending on the interest rate being offered on the new card, the balance transfer fee could make the switch less attractive.
Interest rates increase after the promotional period is up
A much bigger downside to balance transfers is the fact that the low interest rate is temporary. The credit card issuer that is trying to land your business will offer you a great rate for a limited period of time, but after this period expires you will start to pay a much higher interest rate, like 19.99%. If you’re someone who often carries a balance, you won’t want to use this card again after you’ve paid off the balance transfer.
Payments are first applied to new purchases at standard interest rates
It’s important to note how payments are applied when thinking about doing a balance transfer. Let’s say you transfer $5,000.00 from one card to another. You then make a $1,000.00 purchase followed by a $1,000.00 payment. In this case, the $1,000.00 payment will be applied to your balance transfer, not to the new purchase. Unfortunately, that means you’ll be charged the full interest rate on the new purchase – not the promotional rate you got for your balance transfer – and you won’t be able to start paying it off until your balance transfer is fully paid off. If the interest rate is 19.99%, the new purchase could cost you $199.99 for just one month.
Example: Should Christine do a balance transfer?
Christine has a credit card with an $8,000.00 balance and an interest rate of 14.00%. She is considering doing a balance transfer to a new card. The new card has a 3.00% balance transfer fee and a 12-month promotional interest rate of 0.00%. After the promotional period runs out, the rate jumps to 20.00%. Assuming Christine does the transfer and ends up having a balance of $8,000.00 for three years, will the switch be worth it? (For simplicity, let’s assume the minimum monthly payments total the interest amount each year, so the balance always stays at $8,000.00.)
|Year||Balance||Interest rate||Interest||Balance transfer fee (3%)||Fees per year|
In the first year, a balance transfer to the new card would have benefitted Christine tremendously. Aside from a $240.00 balance transfer fee, she would not have paid any interest charges. If she’d paid off the balance in full that year, she could’ve saved $880.00 ($1,120.00 - $240.00). However, because she kept a large balance for the next two years, the higher interest rate meant that switching cards actually cost her money. The lesson here is not to be swayed by the promotional offer. Enticing as it may be, it’s only temporary.
How to use balance transfer credit cards wisely
Balance transfers can be a great idea, provided you use them correctly. Let’s say you just made a major purchase and need some time to pay it off. A balance transfer to a card with a great introductory interest rate might be the way to go. However, if you plan on keeping a balance passed the introductory period, or think you will make many new purchases with the card, it might be wise to stick with your current card, or look at low interest credit cards instead.