How do balance transfer cards work?

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Let’s cut to the chase and get behind the workings of balance transfer cards right away! Once we’re done doing that, we’ll go over few more aspects of balance transfers which are integral to the process.

The term ‘balance transfer’, unlike other complicated financial terms, is fairly easy to understand. A balance transfer is simply the process of transferring your existing balance on a credit card, to another one.  So, you pay off one credit card using another. Quite evidently, a balance transfer doesn’t reduce your debt liability in any way. You still need to pay back the original amount you had borrowed! All it does is that it moves you debt from Card A to Card B.

But why bother doing that?!

Most credit cards charge interest rates (APRs) in the range of 12% to 24%, and sometimes even more!

Now, if you’ve an outstanding balance of $6,000 on a credit card A (from Sam’s Bank, and with 20% APR), you could be paying around $100 per month only towards the interest component. So, if you make a $150 credit card payment per month, only $50 would be utilized for reducing your outstanding principal, the remaining ($100) would be used towards the interest, and go into the issuing bank’s pocket.

Now which bank wouldn’t like to bag that sort of ROI! Drumroll!! Card B (the balance transfer card) from Dan’s bank enters into the picture! Here’s what happens!

  • Dan’s bank emails you an offer that they’d transfer your $6,000 balance on Card A to Card B, and give you a 0% APR for 15 months if you transfer that balance within 30 days of opening an account with them.
  • You apply for Card B with Dan’s bank and your application for their balance transfer card is approved.
  • You provide Dan’s bank with your Card A account number and the outstanding balance on it.
  • Dan’s bank pays off that balance (to Sam’s bank) in full.
  • Dan’s bank also charges you a one-time balance transfer fee ranging between 3% and 5% of the outstanding balance transferred.
  • Dan’s bank is your new creditor now and you start making your monthly payments to them.
  • Everyone’s smiling!

How you benefit here is that you won’t have to pay any interest (APR) on the transferred balance for 15 straight months (as per the terms of balance transfer card). Now your monthly $150 payment would be used entirely for servicing your outstanding principle/debt. Even if you continue paying a minimum of $150 per month for 15 straight months, you’d have reduced your outstanding balance by over $2000, saving yourself many hundred dollars’ interest payment in the process.

When should you use such cards?

If you are financially stable and are in a steady well-paying job, transferring your high APR balance from one card to another, for saving on interest and for paying off the entire outstanding faster, may work as a very smart move. However, please keep in mind that majority of such cards come with a balance transfer fee of 3% to 5% (Chase Slate being the only exception as it has no balance transfer fee and provides a 0% Intro APR for 15 months).

When you should not?

On the other hand, it may not be that good a move to apply for a balance transfer card if your credit score is low because of late payments or some other reason/s. The chances are high that your card application may get rejected. You’ll need a healthy credit score to be eligible for a balance transfer card.

A balance transfer card can also go against your financial interests if your debt is already too big. Although you may receive some temporary relief from the monthly interest payments, you’re most likely to find yourself using your old/new card once again when the situation gets tight.

To opt for low regular APR or Intro 0% APR

You may think that it’s a given that everyone would love to use the 0% Intro APR of balance transfer cards!

No Sir/Ma’am!

0% Intro APR makes sense only if you have a small outstanding balance which you are confident of clearing during the tenure of the 0% APR offer period (ideally 12 to 18 months). In case you go with the 0% Intro APR and are unable to clear your debt during that time, the regular APR of the balance transfer card will kick in, which may even be higher than your current APR. The entire purpose of balance transfer may get lost in that case.

The solution lies in balance transfer cards with low regular APRs. You can ditch the 0% APR balance transfer cards for the ones with low regular APRs if you feel that you’ll need more than a year to pay off your entire outstanding. For instance Barclaycard Ring Mastercard has zero balance transfer fee and low regular variable APR on balance transfers and purchases.

Do balance transfers impact your credit score?

Balance transfers have no direct impact on your credit score. Credit agencies don’t factor them in during their evaluations and they don’t get flagged in the credit reports.

Having said that, please note that buying a balance transfer card can indeed impact your financial profile, which in turn may impact your credit score. This may happen in three different ways:

By altering your credit ultilization ratio: Credit rating agencies calculate your credit score based on the overall utilization of your credit lines. It’s done taking into consideration both the aggregate as well as individual utilization of each one of your credit cards/lines. Your overall credit utilization may fall and positively impact your credit score provided you don’t close your old credit card account.

By encouraging you to overspend: A balance transfer may possibly impact your credit score negatively if you use it merely for avoiding your card payments or for funding your reckless spending habits.

By reducing the age of your credit accounts: Credit history, which constitutes 15% of your credit score is based on the average age of your credit accounts and the age of your oldest credit account. Your credit score may not get impacted if you’re transferring balance between your existing credit accounts. However, it may take a hit if you apply for a new credit card and/or close the old credit card account.

By causing hard inquiries: A hard inquiry is made on your credit report every time you apply for a new credit card. Although these inquiries drop your credit score only marginally, they can be very damaging if you apply for too many credit cards or apply for them too frequently.

Final Word

If used wisely, a balance transfer credit card can go a long way in helping you manage your debt effectively. On the other hand using it for wrong reasons can harm your credit score and increase your overall costs/debts.

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