For long-time users of credit cards, there’s no point in reading this. But if you’re a newbie, keep reading because I’m writing this just for you.
Balance Transfer Definition: A transaction where debt is moved from one credit card to another.
Why do people do these? To save money on interest. For example, someone might move debt from a card that charges 25% interest, to a new card that charges 0% (as a promo rate). Doing this doesn’t reduce the current debt, but it does reduce the amount of future interest you will be charged on it.
That’s the definition in a nutshell, but how do balance transfers work? That’s where things can get confusing, so keep reading…
How do you do one?
There are a few different ways you can initiate a balance transfer:
1. Apply for a new credit card offer
When you apply for a major credit card, many will toss in a promotion where they will give you 0% for 6, 12, or 18 months on the balances that you transfer to their card from other cards.
Why do they do this? The first reason is that they’re hoping the incentive will convince you to choose their card vs. competitors. Secondly, their hope is that you will still be carrying a balance when the promotion is over (and then you will start paying interest).
To take advantage of one, on a card’s application you will see a section like this:
Just fill out the account info for the debt that you want moved to your new card.
2. Use an existing card with a promotion
If you already have a major credit card, then there’s a good chance the issuer will occasionally send you balance transfer offers (thru mail or email) as an incentive for you to transfer debt to their card.
Often times, the promotions are less lucrative than what you would get if applying for a brand new card. Why? Because you’re a captive audience – you’re already their customer.
To do a transfer on an existing card, you can use the checks which they mail you, do it online by logging into their website, or over the phone with customer service.
3. Use an existing card without a promotion
You can also do a transfer without a promotion. For example, if you have a Sears credit card with a 25% APR, you may want to move that balance to your Citi Visa card that charges a lower rate of say 15%.
However doing this rarely makes sense. If you’re going to go thru the hassle of moving your balance, you should try to get a 0% offer along with it (either thru a new or existing card).
But wait, there’s more…
If what I’ve wrote above is all you know about ‘em, then you are NOT yet ready to do a transfer! There are some important caveats you need to be warned about:
Caveat #1: There is usually a balance transfer fee
Moving your debt to a card with 0% interest is a no brainer, right? Not necessarily.
When you do a balance transfer, you will almost always be charged a fee – typically 3% to 5% of the amount you are transferring.
This is charged by the card you are transferring the debt to, not the card you are transferring from.
Keep in mind this is separate from the interest rate. So even if an offer gives you 0% APR for 12 months, you will still be paying the upfront fee of 3-5% for the transfer. What is the takeaway here? Get the longest offers possible!
Once in a great while, a promotion will come onto the market the does not charge this fee. But those are quite rare and the drawback is they usually give you 0% interest for a shorter period of time (so it’s basically give with one hand, take with the other).
Caveat #2: You must transfer to a different bank
From the bank’s perspective, what is a balance transfer for? To bring them more business from elsewhere. Does moving a balance from one Citi card to another Citi card accomplish that goal? Definitely not.
An issuing bank will not let you transfer debt amongst their cards. You can’t really blame them for having this policy, because otherwise there would be nothing in it for them. After all, if you could move debt from a Chase card with a 20% APR to another Chase card with a 0% APR, they would be losing money and gaining no new business in the process.
Note: Just to clarify, Visa and MasterCard are not credit card issuers, they are only payment networks. That means you CAN transfer from a Citi Visa to a Chase Visa, etc.
Caveat #3: Using too much of your credit limit is bad
You may assume that consolidating all of your credit card debt onto a single account with 0% is always a good idea. That’s not always the case.
The debt to credit ratio, also known as the credit utilization ratio (CUR), measures what percentage of a credit limit is being used. For example, if you have a $2,000 credit limit with a $500 balance, you will have 25% utilization on that account ($500 ÷ $2,000 = 0.25 = 25%).
This calculation can play an important part in your credit score. Using too much of your available credit is bad for your score! Many folks who are familiar with scoring formulas recommend that you keep utilization below 30% (some recommend even less). Something like 60% or 70%… that’s a no-no.
When it comes to FICO, the utilization is counted a couple different ways:
- On a cumulative basis (the average utilization across all your credit cards)
- On a per account basis (the utilization per card)
Let’s say you have 3 cards; 1 has 80% utilization and the other 2 have no balance (0% utilization).
The cumulative average across all 3 cards would be 26.7% (80 + 0 + 0 = 80. Divide by 3 = 26.67). That percentage should be fine.
However on the per account calculation, the card with 80% utilization would fail miserably. It looks like you’re almost maxing out that card. It doesn’t matter if the average for all your accounts is favorable. Having just one account like that can still bring down your score.
The lesson? Keep this in mind when doing a balance transfer. Even if a card gives 0% interest, don’t go overboard and transfer all your debt to the point that it’s almost maxing out that card.
That being said, saving money should be your numero uno priority. So as long as you aren’t planning to apply for a loan/mortgage in the next 12 months or so, having a small temporary dip in your credit score is probably worth it. Though I would still advise against utilization of above 60%.