In Part 1 of this series, we talked about various strategies for getting rid of credit card debt and eliminating the sometimes-crushing interest charges that eat into money you could be spending o
n things you really want and keep you from saving for retirement or other needs. I’m devoting Part 2 to an in-depth exploration of a strategy known as a balance transfer.
If used correctly, a balance transfer credit card can help you pay down those credit card balances and potentially save you hundreds, if not thousands, of dollars in interest payments. But, if you’re not careful, it can trap you with fees and high-interest payments and even leave you worse off financially than before. So pay close attention to this guide on how to use balance transfer cards to the fullest advantage and avoid the pitfalls they can lead to.
How balance transfers work: By transferring high-interest balances to a new credit card with a low or 0% introductory annual percentage rate (APR), you can save money on interest and pay down debt faster. The key word here is introductory: that new rate is good for a set period of time, ideally 12 to 18 months, and then any remaining unpaid balance will start accruing interest at rates between 16% and 25%. If you don’t pay the balance due before the introductory period ends, you actually could wind up paying more in interest than if you had stuck with your original cards.
What to look for in a balance transfer card: What is the APR (usually between 0% and 3%)? How long do you have to pay down the debt before the interest resets to a higher rate? What is the amount of the fee to transfer debt from your old cards to your new one? (If you are making several transfers, the fees, often 3% to 5% on the amount transferred, can add up quickly.) What will the interest rate be when the introductory period ends? Is there a grace period for new purchases on the card, or will they start accruing interest right away? Check the timing of the promotional rate–how long you have to make the transfer after getting the card–and what the penalties are if you are late with a payment or make another mistake. Know that a balance transfer will affect your credit utilization score, one of the factors that makes up your overall credit score. Keeping the transfer low enough that your credit utilization stays below 30% is recommended. Your credit rating will likely fall at first but likely will improve once the transfer card is paid off because you would be using less of your available credit.
How to proceed: Once you have applied and been approved for a balance transfer card, you must decide how much debt you want to transfer. It’s better to give priority to high-interest balances to maximize your savings. It’s also best not to transfer any amount over what you can realistically expect to pay off during the introductory period. Calculate how much you will pay in transfer fees. For example, transferring $5,000 would cost between $150 and $250, depending on the transfer fee rate. You typically have 60 days to make the transfer. You can make the transfer by contacting your new credit card company, online, on the phone or sometimes by check. The company representative can walk you through the process. Be sure to continue making payments on the original card until the transfer is confirmed so you don’t get charged a late fee if it takes a while for the transfer to go through.
Here’s an example of how a balance transfer can save you money: Let’s say you have a balance of $20,000 on a card with a 20% APR. Your monthly payment is $250 a month for 24 months. That translates to $1,134 in interest over the two-year period. If you transfer the entire balance to a card with a 0% APR for 12 months, and if you pay off the whole balance within a year, you would pay only the 3% transfer fee of $150. You would have a net savings of $984.
Would I be better off with a personal loan? Some financial advisors recommend taking out a personal loan instead of using a balance transfer credit card. That’s because personal loans offer fixed interest rates and structured repayment periods. If you don’t pay off the card balance before the introductory period, you could end up paying higher interest than you would with a personal loan. A couple of other differences: credit cards are unsecured debt, meaning creditors can’t seize your assets if you default; some personal loans require collateral Both options could affect your credit rating initially.
How your credit rating could affect your transfer plans: As with other loans, you need a good credit score to qualify or get the best terms for a credit transfer card. If you have excellent credit (between 740 and 850), you’re likely to get the best offers with long promotional (APR)periods and low transfer fees. Good credit (670-739) means you likely will qualify but won’t get the longest APR period and may be charged higher transfer fees. If your credit if only fair (580-669), you may not qualify for a balance transfer card or the terms will be less favorable. Try to improve your credit score before applying. If you have poor credit (below 580), you’re unlikely to qualify.
Be careful about new purchases: With some card issuers, If you use your balance transfer card to make new purchases and do not pay off that balance each month, you will lose your interest-free period. Interest begins accruing the day a purchase is posted to your account. Some experts advise that It’s best not to use the balance transfer card for anything except paying down the debt you transferred to that card.
Make a repayment plan: Set up a repayment schedule that ensures you can pay the balance in full before the introductory period ends and you get stuck with a higher interest rate on what you still owe. You can treat the balance transfer card as a debt consolidation tool by combining all your credit card debt in that one new card (assuming you can stick with the debt limit on the card) but, again, be sure you can pay off the balance by the time the introductory period ends.
Bottom line: Balance transfers can be a great way to pay down debt faster. But you need to pay attention to transfer fees, which can cut into your savings on interest, and be sure you can pay off the card balance before it resets to a higher interest rate. Balance transfer cards should be seen as a two-edged financial sword: they can be very effective if handled properly but they can harm those who are careless with them.
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