The Pros And Cons Of Balance Transfers
Transferring a balance from a higher-interest credit card to a lower-interest one can be a great way to save money and get out of debt faster. It can also be a great way to get into even more debt and make a bad financial situation worse. This is especially true if in order to do this, you are opening a new credit card and taking advantage of a promotional balance-transfer offer.
Before You Apply for a New, Lower-Rate Card
First find out if anyone who is approved for the card will get the 0% rate, or if it depends on your credit. You may want to skip the latter type of offer since you don't know what rate you'll qualify for until after you apply. Why give yourself the temptation of more available credit if you can't even use the new card to lower your interest rate?
Let's say you do get the new card with a lower interest rate – or just want to shift a balance to a lower rate card you already have. Test out these pros and cons before doing a balance transfer.
Pro: Will It Save Money?
Paying less interest on your credit card debt will, of course, save money. But depending on the deal and the fees, it may not save enough to be worth the trouble. Before you jump, do the math.
Say you have a $3,000 balance with a 30% interest rate. At 30% APR, you're currently paying $900 a year in interest.
Sometimes you can find a promotion with no balance transfer fee and a 0% introductory period APR, but let's assume you have to pay a 3% balance transfer fee, which is common. In this case, it will cost you $90 to transfer your $3,000 balance. Transferring your balance to a card with a 27% APR means you'd be paying $810 in interest a year; add on the $90 balance transfer fee, and you'd about break even after a year.
Conclusion: In this example, you'd need to look for a deal where the APR is less than 27% to come out ahead. Don't forget to factor your time into the equation, though: Transferring a balance isn't worth the hassle unless you're saving a meaningful amount of money. A free, online balance transfer calculator will help you do the math with the dollar amounts and interest rates specific to your situation.
Pro: Will You Get Out of Debt Faster?
You can also use a lower interest rate to pay off your debt more quickly. Suppose you can afford to put $300 a month toward paying down your $3,000 balance. Here's how that process would look at two different interest rates:
Scenario No. 1
Total debt: $3,000
Interest rate: 30%
Debt payment: $300/mo.
Months to get debt-free: 12
Total interest paid: $496.01
Scenario No. 2
Total debt: $3,000
Interest rate: 15%
Debt payment: $300/mo.
Months to get debt-free: 11
Total interest paid: $225.10
Conclusion: Scenario No. 2 gets you out of debt one month sooner compared to Scenario No. 1 (and it saves you $270.91 in the process). A free, online credit card debt payment calculator can help you see how long it will take to get out of credit card debt with the monthly payments and interest rates that apply to your situation.
Con: Are You Exposing Yourself to More Debt?
After transferring your balance from the higher-interest card to the lower-interest one, you should strongly consider closing your higher-interest card. Don't leave that extra credit line available; you might be tempted to use it. If it's not there, you'll have to find more creative ways to meet your expenses and think more carefully about which purchases are really necessary.
But what about my credit score? you might be wondering. It's true that applying for a new credit card and closing an old credit card will affect your credit score. Having one fewer card might lower your total available credit, which can have a negative impact on your credit score if you're using a high percentage of your available credit. Opening a new account can also ding your credit score in the short run.
Conclusion: If your goal is to get out of debt, your first priority should be making decisions that help you achieve that goal. Once you've gotten there, then you can focus on taking steps to raise your credit score.
Exception: If you're applying for a mortgage in the near future, don't risk lowering your score by closing the higher-interest card. Instead of playing the credit card balance transfer game, use the technique called a debt "snowball" to pay off higher interest debts before lower interest ones.
Con: What's Your Potential to Slip Up?
Carefully consider how much new temptation you can withstand before adding to your credit limit. The card to be most careful of is the new one.
To take advantage of a low promotional APR balance transfer offer, avoid making new purchases using the card you've transferred your balance to. It probably offers no grace period on new purchases (see Transferring Credit Card Balances To A New Card) and you don't want to start accruing more interest.
Conclusion: Be sure to make all your minimum monthly payments on time on both the card you're transferring the balance from and the card you're transferring it to. You don't want to get hit with any late fees. What's worse, if you pay late on your new card, you'll usually forfeit the promotional APR and be stuck paying a penalty APR that could be as high as 29.99%. To be on the safe side, look for a card with no penalty APR, such as the Citi Simplicity or the Discover card.
Finally, keep track of the date when the 0% rate expires. Don't expect a reminder from the credit card company – it's banking that you'll miss the deadline and have to pay interest on your balance.
The Bottom Line
Transferring a credit card balance should be a tool to help you get out of debt faster, not a way to deny to yourself how bad your debt situation is by making your payments smaller for a few months. If you transfer a credit card balance for the right reason, understand the fine print, do the math before applying to make sure you'll come out ahead, and create a repayment plan you can stick with, a balance transfer can help you get out of debt sooner and spend less money on interest.