It’s fairly common for consumer debt to pile up to an alarming rate, especially when it involves high-interest rate credit cards. Over time, paying only the minimum payment creates a situation where it feels like the debt may never be paid off in full. That’s a reality when you don’t take advantage of debt consolidation or other reduction strategies when the opportunity arises.
A credit card balance transfer can be a lifesaver for those in debt, but it is important to understand how it works and when it makes the most sense to reduce debt before you pull the trigger.
What is a Credit Card Balance Transfer?
Most consumers who currently have an active credit card or two get balance transfer offers in the mail or online every now and again. However, they may be unaware of what a balance transfer can do for them.
In the simplest terms, a balance transfer is the process of shifting loans and credit card balances to a new or established credit card. The balance transfer eliminates most if not all of the current credit card debt and starts new with a different card. The intent behind a balance transfer is to lower the cost of carrying a balance, as transfer offers typically come with promotional interest rates that are far lower than standard credit card rates.
Crunching the Numbers
Transferring a credit card balance may seem like a pointless task on the surface, but when you take a close look at the numbers, it can make strong financial sense. Let’s say you receive a balance transfer offer that comes with a 0% annual percentage rate (APR) for the next 15 months. If your current credit card debt is on a card with a 19% APR, you could essentially be saving those interest charges calculated on the balance for the next 15 months. With this example, paying $100 per month on a $5,000 balance, it would take a little over eight years to pay off the card!
With a balance transfer, you can seriously expedite your debt paydown, based on the low to zero interest rate. Your payments are applied toward the principal balance only, since there is no interest accumulation, meaning your debt balance can disappear quickly. Taking the same example above, and maximizing on the 15 months 0% interest offer, you could effectively pay off the new $5,000 credit card balance in that time frame with a monthly payment of $334.
More Pros & Cons to Consider
While credit card and other loan debt balance transfers seem like the end-all to interest accumulation, there are things to consider. Most financial institutions offering balance transfers only do so to highly qualified consumers. That means your credit needs to be strong in terms of score, payment history, and credit utilization in order to be offered a balance transfer in the first place.
Balance Transfer Fees
Next, credit card issuers make no interest-related revenue from balance transfers if you pay off the transfer before the end of the promotional period, but that doesn’t mean there is no cost to taking this route. Balance transfers often come with one-time fees, either as a stated dollar amount or a percentage of the balance transferred – usually 2-5%. It is necessary for cardholders to understand what these fees are and how they are applied to the balance transfer card before committing to this strategy.
Optimizing Your Results
Finally, balance transfers are mostly beneficial to those who are dedicated to not adding to their credit card’s debt in the future. If you do not have a strong grip on your spending or know a major purchase coming up must go on that same credit card and be repaid over time, a balance transfer might not do you much good. Your monthly payments will usually go toward your 0% interest debt first before paying down your newly acquired higher interest debt. You’ll simply be paying down the balance transfer amount before the new, immediate interest charging debt you accrue.
Final Thoughts
Before transferring balances to a credit card, use the above tips and take into account other personal factors first, when considering whether it’s the right debt consolidation move for you.
