Managing credit card debt can feel overwhelming; it’s the kind of debt that can add up quickly and leave you wondering how you’re going to settle it.
Luckily, there are ways and means of dealing with credit card debt that can make it easier to pay off. In this Remitly article, we’ll look at one particular method of easing this type of debt—a credit card balance transfer. Let’s dive into how balance transfers work, the costs involved, and how to decide if it’s the right financial move for you if you have high-interest debt.
What is a balance transfer?
A balance transfer is the process of paying off your credit card debt, usually with another credit card. But why would you do this? Doesn’t it seem a bit redundant?
The main purpose of a balance transfer is to save money on the interest you pay, so you can reduce the total amount you need to repay and shorten the loan term.
It works by applying for a new credit card that has a lower annual percentage rate (APR) attached to it. Many credit cards offer perks like special introductory APRs, where you pay little to no interest on the principal debt for a set period of time.
And while it might seem like a lower interest rate wouldn’t make that much difference, over the long term, it can significantly reduce your overall debt or the loan term.
If you have multiple high-interest credit cards, a balance transfer can also simplify all of them into one single monthly bill, which makes it easier to keep track of your debt.
How does a balance transfer work?
Here are the basic steps to understand before you consider a balance transfer:
Step 1: Application
You’ll apply for a loan with a balance transfer facility and provide the details of your outstanding debts, such as the amounts you owe, who the service providers are, and the account numbers. The loan provider will then assess your creditworthiness before approving (or denying) your request.
Step 2: Initiation
At this step, if you’ve been approved, you request the balance transfer. This might happen automatically, depending on the loan provider, or you’ll need to do it manually. It’s at this point that your new loan provider will contact your existing ones and make arrangements to pay them off.
Step 3: The transfer
Your new lender will pay off your outstanding debts, and these amounts will be transferred to the new loan. Be sure to continue all repayments to your old accounts until the transfer has been confirmed as complete. You don’t want to end up with missed-payment penalties.
Step 4: The payoff period
Your debt is now consolidated into one monthly payment, hopefully with a lower or zero-APR for a fixed term. It’s recommended that you make at least the minimum monthly repayment, but if you can make more, you’ll pay off the debt faster. It’s also a good idea to pay off as much as possible during the lower or zero APR period (usually 12 to 24 months).
Understanding the costs and fees
While you aim to save money through a balance transfer, there are some additional expenses to be aware of. For example, you’ll typically pay an upfront, one-time balance transfer fee. This is often a percentage of the total loan amount you’re transferring, usually 3% to 5%. So, if your debt is $1,000 USD, you’ll pay a one-time fee of between $30 and $50.
Moreover, once the promotional period is over, you’ll need to pay the regular interest rate if you haven’t yet paid off all the debt.
Plus, if you buy anything on the credit card after the balance transfer, it won’t fall under the APR promotion, and you’ll need to pay the regular interest rate on it.
When researching credit cards for your balance transfer, it’s worth checking to see if you’ll need to pay any annual fees. Most credit cards don’t have fees, but some such as American Express or Capital One Venture or Venture X—which offer benefits to their customers—come with an annual fee. Factor these charges into your calculations so you can be sure you’re saving money in the long-term.
Pros and cons of balance transfers
There are numerous benefits to using a balance transfer. These include:
Pros
- Significant savings: When done right, you can save a substantial amount of money by not paying interest on your debt during the promotional period of the balance transfer loan.
- Faster debt repayment: Because you’re not tied to a high interest rate for a while, it means you can pay more of the principal debt, thereby reducing your loan repayment period.
- Simplified monthly budgeting: Once you conduct a balance transfer, all your debt is neatly tied up into one monthly repayment, making it easier to budget.
Just as there are advantages to balance transfers, there are also downsides. It’s not the right solution for everyone. Here are some of the cons:
Cons
- Upfront transfer fees: You’ll pay a one-off fee when you set up your balance transfer. This is typically a percentage of the total loan amount, around 3% to 5%.
- Potential for higher debt: Anyone can fall into a debt cycle. Once you’ve moved all your debts into one single monthly payment, the temptation to continue spending on your new card exists.
- Temporary promotional period: The low or zero APR won’t last forever. That’s why it’s recommended to pay off all—or as much as you can manage—of your debt before this period ends. Otherwise, you’ll end up repaying your debt at the standard APR.
- High credit score is usually required: Balance transfers are often only approved for people with a good credit record. If your credit score is fairly low, you might have a hard time getting your request approved.
- Hard credit inquiries: Applying for a new credit card results in what’s known as a “hard inquiry” on your credit record, which can negatively affect it.
Does a balance transfer affect your credit score?
A balance transfer can affect your credit score, as it results in a hard inquiry. This type of inquiry is characterized by a few factors, including:
- You usually need to give permission for the inquiry.
- They’re visible to other lenders who may look into your credit history.
- They stay on your credit record for a couple of years.
- It may cause a small dip in your credit score.
This is in contrast to a soft inquiry, which doesn’t affect your credit score at all, is visible only to you, and isn’t used to determine your ability to repay a loan.
There are also long-term benefits to conducting a balance transfer, mostly to do with lowering your credit utilization rate. This rate measures how much of your total available revolving credit (such as a credit card) you are currently using. The more credit you use, the less ability you have to pay it back, so a lower rate improves your credit score over time.
However, there are other possible negative consequences of taking out a balance transfer, mainly from closing old accounts early. This reduces the average age of your credits, potentially lowering your score.
Is a balance transfer right for you?
A balance transfer can be a powerful tool for saving money on high-interest debts and helping you pay off your loans faster, but there are downsides to it, too, such as upfront costs and a small dip in your credit score from a hard inquiry.
When you’re determining if a balance transfer is right for you, remember that taking control of your finances is a positive step towards financial freedom, and understanding your options is one of the best ways to succeed.
It’s recommended that you review your current interest rates on your debts and, taking the fees into account, calculate if a balance transfer might save you money in the long run.
FAQs
Can I transfer a balance from one card to another from the same bank?
Most issuers don’t allow transfers between their own products, so you’ll most likely need to switch banks to initiate a balance transfer.
How long does a balance transfer take?
A balance transfer is generally quick, taking around five to seven days to complete. However, because credit checks and settling old debt are involved, it can take up to a few weeks, depending on the issuer. You’ll also need to factor in time to set up a new credit card, which will vary depending on your provider.
What is the limit on how much I can transfer?
Your new credit card will have a limit on it, determined by a number of factors, such as your credit score and how much you can comfortably repay according to the bank’s calculations. You won’t be able to transfer more than the maximum credit available on the card.
Can I still make purchases with the new card?
You can, but it’s discouraged because you’re trying to pay off debt, not take on more. Plus, any new debt you take out doesn’t usually fall under the promotional APR of the card, so you’ll need to pay the full interest on new purchases. This can complicate the repayments at a time when you likely want to simplify your budget.