Debt Elimination Strategies: Balance Transfers Do’s and Don’ts
If you're losing sleep over your credit card debt or just want to escape the debt trap, you should consider the pros and cons of using a balance transfer credit card to reduce your debt load. Credit card companies offer balance transfers, typically with a zero interest introductory rate for six, 12 or 18 months, in order to attract new customers.
According to the 2013 Balance Transfer Credit Card study by CardHub.com, the average household has $6,700 in credit card debt and could save more than $1,000 in interest and fees with a balance transfer credit card. More than half (64%) of the credit card issuers surveyed allow you to transfer debt other than credit card debt, including debt from store credit cards, mortgage and home equity loans, car loans, small business loans, payday loans and even student loans.
These companies are not doing this because they want to help you get out of debt. While the introductory period offers you an opportunity to pay off a credit card balance faster, the credit card companies are hoping you'll neglect to pay it off in full and will pay them the interest you had been sending to another company. In addition, credit card issuers assume you'll need to use credit in the future and that they can benefit from your business.
Savvy credit card users can use a balance transfer to their advantage, but be aware that balance transfer offers are typically only offered to consumers with very good credit. If your debt problems have dinged your credit score, you may not qualify for a balance transfer.
Still, a balance transfer can be worthwhile, if you do qualify. For example, if you have a credit card balance of $5,000 and you have $300 per month to apply to that payment, it will take you 20 months to eliminate the balance on a credit card that charges 19 percent interest. If you switch to a zero percent interest card you can pay it off in 16 months.
Be sure to compare the following features before you commit to a new credit card:
Balance transfer fee. Most credit card companies charge 3- to 5- percent of the balance you're transferring, so use a balance transfer calculator to figure out whether that fee is higher than your interest savings. For example, you'll pay between $150 and $250 to transfer a $5,000 balance. Search credit card websites to see if you can find a credit card offer without a transfer fee, but be aware that the credit card issuer is likely to compensate for the lack of a fee with a shorter zero percent interest period or a higher interest rate after the introductory period.
Length of introductory rate. The length of the zero percent interest period is extremely important, because in order to make a balance transfer worthwhile you need to pay off the balance before the introductory rate expires. Make sure you've done your math homework and calculated exactly how much you need to pay each month in order to pay your balance in full before you start paying interest again. For example, if you want to pay off a $5,000 balance and your introductory period lasts 12 months, you'll need to pay $417 per month to pay it off before the zero interest rate expires.
Post-intro interest rate. The interest rate you pay after the introductory period won't matter if you pay the balance in full and don't plan to charge additional items on your credit card. However, you should be careful to compare rates in case you don't manage to pay the balance completely in time. You don't want to waste your money paying a balance transfer fee and then end up with an interest rate the same or higher than your current credit card.
Annual fee. Some credit card companies offer cards without an annual fee, but other companies charge fees that range from $15 to $300. Add the annual fee to the balance transfer fee as part of your calculation to determine whether your interest savings will offset the cost of the transfer.
After you have been approved for a balance transfer, credit card issuers are required by law to wait 10 days before they make the transfer in order to give you time to reconsider your decision.
Once you've switched your credit card debt to another creditor with a balance transfer, it's crucial to avoid going deeper into debt. When your first credit card shows an available credit limit, you may be tempted to use it again. Don't do it. You could end up with two balances and be unable to pay either bill.
Make sure you pay your credit card bill on time, too, because if you pay late your introductory interest rate will disappear and you will be paying the full interest rate on the credit card.
If you're disciplined and committed to paying off the balance, a balance transfer can be a good tool for eliminating your credit card debt.