It isn’t uncommon for credit card customers burdened by high-interest card debt to opt for balance transfer facility to benefit from the introductory 0% APR offers. Nothing denying the fact that such refinancing can be a very cost-effective move, but it also leads to a hard inquiry into your credit, which is most likely to temporarily affect your credit score.
How your credit score gets impacted
As per FICO (Fair, Isaac and Company), any such hard inquiry made on credit leads to a temporary drop of around 5 or less points in the credit score. However, it’s normal to see the credit score bounce back up after a few months’ time as you start repaying your debts in time. In fact, in many cases, the credit score even gets better than before! The reason for that is while new credit constitutes 10% of the credit score, the total amount owed makes 30% of it. When we talk about the total amount owed, it isn’t necessarily about the actual dollar amount owed by you, but more about your credit utilization ratio. You need to divide the total amount owed by the total credit limit available to you (across all your credit cards), to arrive at this ratio.
Let’s assume that you owe $ 10,000 as credit card debt, and it’s the only debt you owe. You have only one credit card, with a limit of $ 15,000. At this point, you are provided an opportunity to transfer that $ 10,000 balance to another credit card offering an attractive limited period 0% APR facility. The new credit card also offers you an extra $ 5,000 credit line.
There’s a 3% fee associated with this balance transfer facility, so essentially your new total credit card debt will become $ 10,300 post the transfer. However, where things get interesting is that while your credit utilization ratio was 66.6% earlier, it’d become 51.5% after the transfer is complete (taking the balance transfer fee into account). Although you may owe a little more money to the card issuer, you’re most likely to see a jump in your credit score owing to lowering of the credit utilization ratio. The $ 300 fee paid by you would be put to excellent use as it’d probably save you a good deal of money in the long term. Let’s understand how.
How a credit card balance transfer saves you money
Even though you may owe an extra $ 300 on your credit card, having transferred your $ 10,000 balance to a 0% APR card is sure to save you a good amount of money in the long run. In this example, the introductory 0% APR offer is applicable for the first 18 months, followed by 15% APR (once the promotional period ends).
Let’s say you make monthly payments of $ 250 right now, and are charged 18% APR on your $ 10,000 balance.
Assuming that you avoid opting for the balance transfer facility and continue making these $ 250 monthly payments, it will take you 62 months and a total of $ 5,386 in interest to become debt free. Your total outgo, in that case, would be $ 15,386.
On the other hand, if you do opt for the balance transfer facility and continue making the same $ 250 monthly payments, you could free yourself of your card debt in 46 months, and pay only around $ 1,093 in interest. Your total outgo in this scenario would be $ 11,393.
What more, you could even opt for another balance transfer at the end of the first 0% APR promotional period, transferring the remaining balance ($5,800) to another 0% APR card (with $300 transfer fee) for an additional 15 months of interest-free honeymoon, and become debt free in total 44 months, paying just $165.6 in interest!
As you can see, the initial temporary hit you take on your credit score and the $300 balance transfer fee can save you tremendously by opting for single or multiple balance transfers.
Simply put, it’s definitely worth it!
When it may be better to wait
In case your credit score isn’t in a very good shape, it may be better to wait until it climbs back up into a respectable ‘good’ range, which is 680 or above, before applying for any balance transfer credit card. Financial institutions are generally hesitant in accepting balance transfer card applications of people whose credit score is below 680. However, they need to make a hard inquiry to obtain that information. It would mean that your score will still drop, and you’ll not be able to reap any benefits of the reduced credit utilization either.
Hence, if you’re somewhere close to the magic 680 figure, it’d be good to wait a little more. In fact, you can do certain things which are likely to increase your credit score instead, for instance continuing making minimum payments on your card/s each month and paying all your other bills in time, to avoid anything delinquent popping up in your credit report.
Continuing making all your payments on time is most likely to result in your creditor passing positive details to the credit agencies. At least, nothing negative would be reported.
Furthermore, you can even make higher than minimum payments and reduce your balance/s rapidly, lowering your credit utilization ratio and positively impacting your credit score.
Any increase in your credit score is highly likely to qualify you for better interest rates when you apply for the balance transfer card later.
It may also be better to wait for balance transfer credit card application if you’re planning to take out a mortgage anytime soon. Buying a home is easily one of the major purchases that you’re likely to do in your entire life. It’s best to keep your credit score in good shape when you submit your documents. Taking even a slight hit due to a hard inquiry (resulting from a balance transfer card application) can negatively impact the offered interest rates on a mortgage.
If you qualify for a balance transfer card right now and don’t have any major purchases coming up in the near future, it may make a lot of sense to take that small and temporary credit score hit, and save a lot of money in terms of interest, in the long-term. Just ensure that you continue making the minimum due payments on the new card (without fail) after the balance transfer is complete.