Balance transfers on credit cards can be an attractive proposition for both consumers and credit card companies. For consumers that are carrying a considerable balance and no immediate path to paying it off, it can allow a period of time where they can pay down the debt, while temporarily lowering, or even eliminating, interest payments. For credit card companies, they use this hook to acquire new customers from competitors. There are definitely things to keep in mind when considering a credit card balance transfer.
Why get a balance transfer?
If you are having a hard time paying down your credit card balances because you have a high-interest credit card, then a balance transfer could be a good solution for you. A favorable balance transfer offer has a 0% interest incentive period for up to 18 months. If you are able to apply the amount you usually pay in interest toward paying down the principle, then this strategy could work well for you. One thing to be aware of before pulling the trigger on a balance transfer is the Transfer Fees.
What are balance transfer fees?
Credit card companies use low or 0% introductory rates as a way to acquire new customers, but they can also include a small fee to offset their costs by changing a fee based on the percentage of the balance being carried over. Most range from 3% to 5%. So if you are pulling $15,000 from a high-interest card into a balance transfer, a 3% fee would be $450. Paying $450 to not be charged interest for 18 months isn’t a terrible deal, but you need to be aware of it and use the time to pay down your balance.
What are incentive periods?
With a credit card balance transfer, the incentive period is usually 12-18 months and includes a 0% interest rate on the balance that was transferred during that time. Be sure you are considering the APR (Annual Percentage Rate) of the new credit card you are transferring your balance to, because many times new purchases will incur finance charges at the regular rate of the card and not be included in the incentive period. Most credit cards have fairly high interest rates once the incentive period ends, so you could be paying 20% to 25% interest on the balance again.
What is APR?
APR or Annual Percentage Rate is the simple interest charged on the amount of money being owed, as a percentage. Credit card Annual percentage rate is calculated by dividing your APR rate by 365 (number of days in a year) to find the daily rate. You are charged interest by the average daily balance.
Example 1: If you owe $10,000 on a 20% APR credit card, and pay $500 per month, it will take you 25 months to pay off the card and cost you approximately $2,040 in interest.
Example 2: If you owe $10,000 on a 20% APR credit card, and pay $250 per month, it will take you 65 months (over 5 years) to pay off the card and cost you approximately $6,230 in interest.
Using a credit card balance transfer can be a good way to tackle your credit card debt, but it isn’t for everyone and can be kicking the can down the road for some people that don’t use the opportunity to pay down the balance. There are good alternatives to a balance transfer that can be beneficial in the long-run and allow you to reduce your interest rate, like a debt consolidation loan, personal loan, or if you own your home, a home equity loan or cash out mortgage refinance. Each of these options will have credit score and income eligibility requirements. If you don’t have a decent credit score (690+) then you may have trouble getting approved and you may want to consider debt settlement. Do your research when considering any of these debt consolidation solutions.