However, before you pursue a balance transfer, be sure to understand how these options may impact your credit scores.
How balance transfers work
A balance transfer is just what it sounds like: You transfer the balance from an old credit card to a new one with better terms and a lower interest rate. Generally, the 0% or low introductory interest rate on a new account will last for a limited amount of time (typically six to 18 months). For people struggling with credit card debt, a balance transfer offers the chance to pay down their balance without worrying about accumulating interest for a certain period of time.
A balance transfer can result in significant savings. For example, if you transfer a $10,000 balance from an account with a 15% interest rate to a card with no interest for the first 12 months, you could save $1,500 during that initial year.
Additionally, balance transfers can simplify your finances by letting you consolidate all of your credit card debt onto one card. That way, you don’t have to keep track of multiple accounts and monthly payments.
Although you could save money overall, you’ll probably have to pay a transfer fee, which is typically 3% of the balance you transfer. Some cards might also involve an annual membership fee. Avoid these types of accounts as the annual fees could negate your overall savings.
Consumers considering balance transfers should also determine whether the card issuer offers a 0% annual percentage rate on balance transfers alone or on both transferred balances and new purchases. Typically, your new account will specify two different interest rates: one for the transferred balance and another one for any new purchases you make with the card.
When looking into balance transfers, you should understand how payments will work for the new card. Generally, payments will go toward the transferred balance first, if it has a lower interest rate, then new purchases.
Types of balance transfer cards
Various banks and credit card companies offer balance transfer deals. Typically, these accounts fall into one of two categories: cards that are meant for the sole purpose of consolidating or restructuring debt and those that offer rewards programs and are meant for long-term use.
Before settling on one of those categories, consider how you intend to use the new account. Cards that are not designed solely for balance transfers have their drawbacks. For example, a rewards card might offer 12 to 15 months of 0% interest, whereas a card designed for debt consolidation and balance transfers might offer a low interest for a longer promotional period lasting up to 21 months. It’s also important to note that certain balance transfer cards might waive the typical transfer fee.
One big advantage of balance transfer cards is the potential to greatly reduce the amount of interest you pay on your debt. By lowering interest, you have the opportunity to put more money toward the principal amount you owe and potentially pay off your debt faster than you would be able otherwise. The biggest drawback, however, is the possibility of mismanaging your credit cards and racking up more debt instead of paying it off.
Balance transfers and your credit
To get a new credit card with a low or 0% interest rate, you often need good credit scores. If you have low credit scores and still manage to get approved for a new card, the interest rate will probably be too high to make the balance transfer worthwhile.
Because a balance transfer involves opening up a new line of credit, it will also lead to a hard credit inquiry, which will cause your credit scores to decrease initially. However, in the long run, the transfer could have a positive impact on your credit history if you are able to pay down your debt faster (improving your debt-to-credit ratio) without any interest accumulating on the new card.
Finally, opening a new account will increase your available credit and lower your credit utilization rate, or debt-to-credit ratio. Still, you could end up hurting your credit scores if you’re not careful. Continuing to use the old card — even after completing a balance transfer — could increase your utilization ratio, add to your debt and potentially get you back into the same situation that led you to seek a balance transfer in the first place.
