If you have debt, chances are you’re looking for smart ways to reduce it. One debt management approach you may have heard about is the balance transfer. But what exactly is a balance transfer, and is it a good fit for your financial situation?
There’s no doubt that debt is stressful, and it can be tempting to jump at a chance to minimize it in any way possible. But before you sign on any dotted lines, make sure you understand the benefits and risks of making a balance transfer, so that you’re truly making your financial situation better, not worse.
What is a Balance Transfer?
Generally, a balance transfer occurs when you move debt from an existing account to a new account to take advantage of a lower interest rate. So, for a credit card, a balance transfer would mean you get a new credit card with a different bank or institution and transfer all or part of the outstanding debt from your existing card to that new card.
Credit card companies will offer low or zero percent interest rates for a set introductory period, which can be very appealing since many cards carry an APR above 20%. However, they also charge transfer fees between zero and five percent of the amount you’re transferring. And once the introductory or promotional period is over, the interest rate goes up, sometimes significantly.
5 Factors to Consider
A balance transfer sounds simple enough, and it could help you save a good amount of money. But the devil is in the details — it’s important to look closely at the terms of a given offer so that you lighten your load rather than add to it. Here are 5 factors to consider before making that balance transfer:
- Interest Rate: How does the new interest rate compare to your existing rate? If there isn’t a big difference, you may want to keep your debt where it is and focus on repayment, or find a rate that offers you more savings.
- Fees: The company receiving the balance transfer will typically charge a one-time balance transfer fee, such as 3% of the amount transferred. They may also have an annual fee. Will these fees exceed the amount you would save from the new interest rate?
- Promotional Period: This is the timeframe during which your new credit card company will charge you that low interest rate. Once that period is up, the interest rate shoots up too. Search for an offer that gives you enough time to pay off all or at least most of your debt during that introductory period.
- Balance Amount: You may not be approved for a full balance transfer. The new card issuer will decide how much they’ll take on based on your credit score and company policies such as transfer limits. If you’re approved for a partial transfer, you’ll need to remember to make ongoing payments to both cred card companies.
- Penalties: It’s important to read the fine print on this one. What happens if you miss a payment? Are there additional fees that get added to your balance? Does your interest rate shoot up, negating the whole point of transferring your debt in the first place?
Understanding the terms of your balance transfer before you jump in allows you to choose an offer that’s right for you, with as few surprises as possible.
How to Make a Balance Transfer
Now that you know what a balance transfer is and the key elements involved, you can begin the process. Start by creating a detailed budget that gives you a clear understanding of how much you can realistically pay each month. Then, shop around for an offer that works for your situation.
Look for 0% interest rates where you can pay off the balance during the promotional period, which could be anywhere from 6 months to 21 months. This is especially important during times of financial hardship or extra stresses. Read the fine print so you can compare fees, penalties, and post-promotion interest rates. Once you’ve found an offer that looks compatible, gather the information on your current debt balance (amount and account information) and call or apply online.
Stick to Your Guns
Once you’ve gone to all the trouble of understanding what a balance transfer is, researching offers, comparing terms, getting approved, and transferring your debt, the last thing you want to do is miss this opportunity to get your finances under control. So once you have transferred your debt to a low or zero interest rate, avoid the temptation to make only the minimum monthly payments or to add to the balance with new purchases.
Instead, put as much money as possible toward your monthly payments and make those payments on time. To help yourself do that, create a budget each month, keep close track of income and expenses, and be disciplined about avoiding unnecessary purchases. Lastly, remind yourself that the temporary pain of not spending the way you’d like now will lead to the immense gain of improving your financial wellbeing overall.
- How to Ask Creditors for Loan and Credit Card Forbearance (Freedom Debt Relief)
- How to Use Credit Cards Wisely After Debt Settlement (Freedom Debt Relief)
- 7 Ways to Tackle Your Maxed Out Credit Cards (Freedom Debt Relief)
- Best Balance Transfer Credit Cards of April 2020 (Fool.com)