What is a Balance Transfer: How It Works, Credit Score Impact, Fees & More

What is a Balance TransferA credit card balance transfer is exactly what the name suggests – it’s a process that enables you to move existing debt to a new credit card account in order to garner a lower interest rate, save money, and pay off amounts owed faster.

All major credit card companies allow you to transfer credit card debt to a new credit card account, according to CardHub’s Balance Transfer Policy Report.  Certain issuers also allow the transfer of auto loans, student loans, small business loans, payday loans, HELOCs, and mortgages.

However, just because you can transfer a balance doesn’t mean you should.  In order to determine if a balance transfer is wise given the specifics of your financial situation, you must first understand how the process works, what costs are involved, and how the transaction may affect your credit standing, rewards earning capabilities, monthly payment, etc.  We’ll discuss those issues and more below.

How Do Balance Transfers Work?

When you transfer a balance to a credit card, that card’s issuer pays off your debt obligation with the original lender, be it another credit card company, a credit union, or a loan servicer.  This satisfies your original agreement and shifts your payment obligation to the new card’s issuer.  The original lender cannot prevent you from transferring away a balance, as all they see is a payment being made on your behalf.

You can request a balance transfer at the same time that you apply for a new credit card or at a later date.  However, it’s important to note that many credit card companies offer introductory balance transfer interest rates – often as low as 0% – for the first 6-24 months that you have a new card, if you request it within the first 30 days.  You should also be on the lookout for balance transfer fees, especially with 0% offers, but we’ll address such costs in more detail below.

In order to perform a balance transfer, you will need the following information:  the account number linked to the balance you wish to transfer, the amount to be transferred, and the personal information that is always required when applying for a new credit card (i.e. your name, Social Security Number, employment information, income, etc.).

Types of Balances Transferable to a Credit Card

The types of balances that you can transfer to a credit card depend on which bank you get your card from.  The graphic below illustrates transfer-eligible debts for each of the 10 largest credit card issuers in the United States.

Balance-Transfer-Study

Source: CardHub 2013 Balance Transfer Study

Balance Transfer Fees

Credit card companies typically charge a fee equal to 2-4% of the balance you transfer in return for processing the transaction and assuming your debt obligation.  This fee is charged by the issuer you transfer your balance to and cannot be charged by the issuer that originally held your debt.

While balance transfer fees can prove quite expensive, even neutralizing potential savings derived from a lower interest rate, consumers often fail to appreciate their significance before the fact.  That’s largely because the balance transfer fee is one of the least clearly represented account terms on credit card applications, as revealed by CardHub’s annual Application Transparency Report.

Every so often, a free balance transfer credit card – one that charges neither a transfer fee, nor interest for the first few months – will be available to people with excellent credit.  Getting such a card is the only way to avoid paying balance transfer fees entirely.  In the absence of such an offer, you can minimize the cost of a balance transfer by comparing offers in terms of their total cost (i.e. transfer fee, annual fee, and total interest incurred based on your payoff timeline).  A credit card calculator will prove extremely helpful in this regard.

Balance Transfer Rewards

A balance transfer, in theory, represents a significant rewards earning opportunity.  After all, credit card companies offer rewards on every dollar you spend, and transferring a balance basically entails drawing down your credit line on a particular account in order to pay off an existing debt obligation – typically a high-dollar-value transaction.

Unfortunately, most credit card companies specifically exclude balance transfers from rewards earning eligibility.  Not all of them have such policies, though.  As of September 2013, three of the 10 largest credit card issuers – Barclaycard US, Chase, and U.S. Bank – enable you to earn rewards on transferred debt with some of their card offers.

You can determine if a given card offers balance transfer rewards by reading the fine print of the card agreement.  Keep in mind, however, that just because a balance transfer card offers rewards doesn’t necessarily make it a good deal.  It just means that you’ll need to factor the rewards value you stand to glean from the transaction into the total cost of the transfer in order to evaluate its overall benefit.

Do Balance Transfers Hurt Your Credit?

A balance transfer itself has absolutely no direct impact on your credit standing.  Balance transfers aren’t flagged on your credit reports, and credit scoring companies don’t specifically factor them into their evaluation criteria.

With that being said, a balance transfer can lead to changes in your financial profile that will affect your credit score.  The potential impact is threefold:

  1. Credit Utilization:  A balance transfer can alter your credit utilization ratio – a key component of the Amounts Owed portion of your credit score.  Credit scoring companies calculate utilization for each of your credit lines individually as well as all of them on aggregate.  As long as you don’t close the original account, your overall utilization will fall.  At the account level, how your new card’s utilization ratio compares to that of your original card prior to the transfer being made depends on whether the new card has a lower or higher credit line.
  2. OverspendingBalance transfers can also have negative credit score implications if you use them to avoid payment or to facilitate risky spending habits.  Prior to the Great Recession, it was common for consumers to hop from 0% credit card to 0% credit card in order to prevent interest from ever accruing and effectively delay the inevitable.  At some point, you are going to have to pay for what you charge, and the folks who tried to game the availability of 0% balance transfers found that out the hard way when such offers dried up during the credit crunch.  Many of them were unable to pay off the balances they had amassed, especially given the pressure of expensive finance charges, and therefore ended up missing payments and even defaulting on their obligations, ruining their credit in the process.
  3. New CreditEach time you open a new credit card account, your credit score takes a temporary dip that can last 3-6 months.  Unless you have a major financial event in the near future – such as applying for a mortgage – this should not be a concern.

Balance Transfer Tips

 

  • Decide How Much to Transfer:  It’s important to note that a balance transfer doesn’t have to be for the full amount that you owe.  Partial transfers are not only acceptable, they’re actually wise since they can enable you to utilize a card’s 0% intro period without worrying about how regular rates will affect the portion of your balance that you cannot pay off during the intro term.
    In order to determine the proper transfer amount, identify what monthly payments you can comfortably afford and multiply that figure by the number of months you’ll have a low introductory interest rate.
  • Make a Payoff Plan:  Balance transfer credit cards must be used strategically, or not at all.  That means you should only open one for a specific purpose and with an exit strategy in mind.  A credit card payoff calculator can help you determine what monthly payments you’ll need to make in order to be debt free by the time regular rates kick in or, alternatively, how much you’ll save with a predetermined payment in mind.
  • Don’t Assume 0% Rates Will Always be Available:  As mentioned above, the availability of 0% balance transfer credit cards isn’t a given.  You should therefore approach each balance transfer that you make as if you’ll have no choice but to pay regular rates at the conclusion of the introductory period.  If you are able to transfer another balance down the road, great, but banking on it is a recipe for a less robust bank account.
  • Understand the Various Ways One Can Leverage Balance Transfers:  A balance transfer credit card’s most obvious value is as a debt management tool.  The right card can help you mitigate interest and therefore escape debt at the lowest possible cost.  That’s the case whether you’re leveraging a balance transfer to pay off an upcoming big-ticket purchase, a lone revolving balance, or as a means of debt consolidation.Interestingly enough, you can also use a balance transfer as a savings mechanism.  If your bank account’s interest rate is high enough, then leaving the majority of your would-be monthly credit card payments in the bank during a balance transfer credit card’s interest-free introductory period can be financially beneficial.  This strategy is only advisable if it doesn’t become an excuse to spend more than you otherwise would.
  • Carefully Compare Offers:  There are usually a number of different balance transfer credit cards available at any given time.  Garnering the most financially advantageous offer necessitates determining which ones you’re eligible for, then comparing the total savings attainable with each.  Balance transfer savings are dependent on a given card’s interest rates, fees, and introductory period (if applicable).  Consumers too often hone in on one particular aspect of a balance transfer offer – typically the length of its 0% term – but it’s important to consider the overall impact of all potential cost drivers.
  • Keep Your Original Account Open:  Even if you aren’t going to continue using the account from which you transfer a balance, you should still keep it open.  This will prevent your overall credit utilization ratio from changing for the worse.  Just make sure your card does not charge an annual fee.
  • Don’t Use a Transfer as an Excuse to Overspend:  Thinking, “I’m not getting charged interest, so it doesn’t really matter how much I spend,” is the worst mindset you can have when it comes to a balance transfer.  You’re going to have to pay up at some point, so make sure to use a balance transfer credit card in accordance with a well-thought-out budget.  Otherwise, any savings you do ultimately glean will quickly be erased by finance charges when regular rates inevitably take effect and you may even incur significant credit score damage if you can’t foot the bill.
  • Don’t Make New Purchases with Your Balance Transfer Card:  Anytime you revolve a balance on a credit card, there is no grace period for purchases, which means that unless your card offers 0% on purchases, any purchase you make will begin accruing interest immediately. Obviously, no one wants purchases to be more expensive than they have to be, so use a different credit card for making everyday purchases and earning rewards, at least until you pay off your transferred balance.

Bottom Line

Balance transfer credit cards can be extremely valuable debt management tools and are even conducive to maximizing the value of a savings account.  Benefitting from a balance transfer offer, however, necessitates using it for a specific purpose, carefully evaluting the total cost of all available offers, and executing a strategic debt payoff plan.  Using a balance transfer card for the wrong reasons is nothing but a recipe for increased costs and credit score damage.

 

 

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