If you currently have credit card debt, you might be looking to transfer your existing balance to a balance transfer credit card with a 0% introductory rate. While this can be a good repayment option, you need to weigh the potential benefits and risks to determine if balance transfer credit cards are the best option for you. These are several factors you should consider before applying for another credit card?
How Balance Transfer Credit Cards Work
No doubt you have probably received an offer or seen an advertisement that allows you to transfer the balance from your existing credit card to another card and pay 0% interest for the next 12 to 18 months. After the introductory period, the interest rate returns to the normal amount near 20%. This is the standard introductory offer that balance transfer credit cards use to attract new applicants with credit card debt.
With the current credit card interest rate averaging 19.24%, that can potentially save you thousands of dollars in interest if you can pay the entire balance off within the 0% timeframe instead of only making partial payments for the next few years.
You might think this is a money losing proposition for the credit card companies, but, they make money in three different ways:
- They might charge a one-time transfer fee of 3% meaning they make a small profit even if you pay the entire balance off in the introductory period
- A sizable percentage of applicants will still have a balance remaining after the 0% introductory rate expires and pay the regular interest rate on the remaining balance
- They earn a small percentage in transaction fees for each new transaction you charge to the credit card
Advantages of Using a Balance Transfer Credit Card
There are several advantages to using a balance transfer credit card instead of continuing to make monthly payments to your current credit card company.
The 0% introductory rate is essentially an interest-free loan, especially if you can avoid balance transfer fees. Since credit cards charge some of the highest interest rates this is a really good way to save money long-term. And, about the only two times you can usually obtain 0% financing is when you buy a new car with dealer financing or purchase new furniture.
Here’s a bonus suggestion to repay the balance even quicker. A portion of your current credit card payment is applied to the interest that has accrued since last month’s payment. Make the same payment you are currently making (principal plus interest) as the payment portion that was applied to interest will now be entirely applied to the principle. This can mean the difference between repaying the entire balance at 0% or paying interest on the last few payments.
The Balance Transfer Fee Is Still Cheaper Than Interest
Even if you have to pay the 3% balance transfer fee, it’s still cheaper than pay 19.24% interest every month. Don’t let a one-time $40 fee (or 3% of your transferred balance) stand in the way of a low interest-rate.
Cons of Balance Transfer Credit Cards
Balance transfer credit cards aren’t for everybody. If you demonstrate one of these behaviors, you may not want to do a balance transfer.
Another Spending Temptation
For some, credit card spending is an addiction of sorts. These same people have a tendancy to actually increase their total debt load because they have a new credit card to “max out” and some introductory offers also charge 0% on all new purchases made within the same period, provided you make the minimum monthly payment. Essentially opening a 0% credit card is an interest-free spending spree instead of a lifeline to get out of debt.
Before they know it, they have yet another maxed out credit card and are in worse financial shape than 12 to 18 months before they applied for the new
Another Credit Inquiry
Each time you apply for a new loan or credit card, another “hard” credit inquiry will be recorded on your credit report and your score will dip slightly. If you are planning on needing new credit in the near future and unsure if you will qualify for it and the balance transfer credit card, this application could potentially disqualify your subsequent loan applications for the immediate future.
How To Use a Balance Transfer Credit Card
If you do apply for a balance transfer credit card, you should follow the steps below.
Transfer Your Balance Immediately
Some credit cards require you to transfer the balance within the first 60 days to avoid paying a balance transfer fee. Transfer that amount and consider canceling your old credit card to avoid running up a new balance. Canceling an account will penalize your credit score, but, it might be the better alternative if you are likely to accumulate another unpaid balance.
Make Extra Payments
Do everything possible to pay off the balance within the introductory period. Since the interest rate is 0%, all you need to do is divide your transferred balance by the number of months. For example, a $5,000 balance divided by 12 months equals a $416 monthly payment.
Don’t Accumulate a New Balance
Depending on the credit limit for the new card, you might be able to spend more each month in addition to the amount you transferred. Avoid new credit card charges as much as possible to avoid reversing the financial progress you made. Pay all new balances in full to avoid future interest charges.
Consider Canceling the Account after Balance is Paid
Once you repay the balance, you will gradually see your credit score improve. You may decide to cancel all your credit card accounts as you pay off the balances and shift to using cash and debit cards. Another reason is if your balance transfer credit card charges an annual fee.
If you can responsibly handle a credit card, you may decide to upgrade to a cash rewards or travel rewards credit card. Balance transfer credit cards usually don’t have the best purchase rewards because they offered such a low introductory interest rate instead.
Is a Balance Transfer Credit Card the Best Option for You?
If you can use the introductory rate to pay down your balance, this is probably the best credit card debt repayment option for you. For those that will probably increase their total unpaid balance should probably avoid this option and those with poor credit scores should consider other options to avoid going into debt even further.