Be warned: transfers can hurt your score (if done the wrong way)
We all know credit card debt is bad, right? So I’m going to skip that whole spiel. Instead, let’s jump right into the current problem: you have a balance and you’re paying oodles of interest on it.
In that scenario a 0% balance transfer offer might seem like the logical choice – and it is – but only you use it the right way.
Do balance transfers hurt your credit score directly? Nope. In fact there’s no way for someone to know how a balance got on a given card when viewing your credit report. They will see your card’s credit limit and how much money you owe on it, but it’s impossible for them to know whether that debt came from regular spending or a balance transfer.
So in and of itself, the act of transferring won’t affect your credit score. But if you end up with too large of a balance, then that will hurt your score!
1. How the credit utilization ratio (CUR) can hurt your score
Credit utilization refers to the percentage of your credit limit that’s being used. Here’s an example:
- You have a credit card with a $10,000 credit limit.
- Your current balance on the card is $1,000.
To calculate your CUR divide, your balance by your credit limit: 1,000 ÷ 10,000 = 0.10
0.10 = 10%. Your credit utilization ratio (CUR) for that account is 10%.
So why do you need to know this? Because part of your FICO credit score measures the percentage of your credit limit which is being used. What’s a good number? The lower, the better.
With the above example, 10% credit utilization is quite low and probably won’t affect your credit score. But what if that number was higher? The consensus in the credit world is that it’s best to keep your utilization below 30%.
If you already have a low/average score, then having a 50% CUR on one account might have little to no effect on your credit score. However if you have a score in the high 700’s or above, then a 50% CUR will be much more likely to hurt your score, perhaps by as much as 20-40 points (or more, if the CUR is really high).
2. How to maintain healthy credit utilization
The secret to doing a transfer that won’t hurt your score is pretty simple: make sure the new balance (after the transfer) isn’t using too much of your limit.
For example if you have a $2,000 balance and you transfer it to a card with an $8,000 limit, then that’s a 25% CUR… which is fine.
But if you transfer $2,000 to a credit card with only a $2,300 limit, that’s a whopping 87% (2,000 ÷ 2,300 = 0.87). That high of a CUR will definitely be bad for your score. Actually, rumor has it that FICO counts any number between 85-100% as the same thing… a maxed out account!
The lesson here can be summed up in a 4 words: KEEP YOUR UTILIZATION LOW!
3. What’s the next step for transferring the RIGHT way?
Here’s why doing a transfer can get a bit messy:
It’s impossible to know in advance the credit limit on a new account. You won’t find out until after you are already approved and the account is open.
So what’s the solution to this predicament? Here’s what I recommend:
Option A: Start out with a small transfer
Let’s say you have $5,000 in debt on 2 different accounts. You want to apply for a new card, but doubt your credit limit will be high since your current accounts only have $4,000 limits each.
One solution is to only request a small transfer amount when you fill out the application. Then if you end up getting approved for a limit higher than expected, you can transfer more.
This works with most 0% offers because they typically honor the 0% promotion on all transfers made within the first 30 days the account is open. Check the application to confirm the rules.
Option B: Transfer to multiple cards
If your debt is so large that you already know your new account won’t have a very high limit, then you may want to consider breaking up your balance onto a couple different cards in order to keep the CUR down.
For example, instead of transferring $10,000 to one card, you might transfer $5,000 to two different cards.
One last caveat…
Your score counts credit utilization in two ways:
(1) on a per account basis
(2) an average across all your accounts.
Both types will be counted separately. This means even if you have 9 cards with no balance and 1 card with a 90% balance, that 1 card will still hurt you on the per account calculation. However, the average account calculation would still be good since there would be those other 9 cards averaging it down.
Even though it’s ideal to have a CUR no higher than 25-30% on a given account, you shouldn’t be overly obsessed about it. Ultimately, saving money is probably more important than whether or not your credit score temporarily drops a bit. Once the balances are paid down, your score should recover quickly.
So if you have one card with a 40-60% balance, it’s definitely not ideal… but if it saves you money, then it’s probably worth it.