When you feel as though you’re drowning in debt, the priority becomes getting out as quickly as possible.
One way to get out of debt a little faster is to use a balance transfer. Being able to move your high-interest balance to a card with a lower rate can provide an opportunity to put more of your payment each month toward reducing your principal — allowing you to get rid of your debt quicker.
However, while a balance transfer can be a big help, there are some pitfalls to avoid. Here’s what you need to know about a balance transfer and how it can help you pay off debt faster.
How does a balance transfer work?
With a balance transfer, you use it to pay off higher-rate debt. In many cases, you receive a special 0% intro APR balance transfer offer to open a new credit card account.
One of the biggest reasons credit card debt is so hard to get rid of is high interest rates. Most of the minimum payment each month covers the interest fees, and the percentage left over reduces your actual balance.
A balance transfer changes that. With a 0% intro APR balance transfer, every penny of your payment goes toward reducing what you owe, allowing you to tackle your debt much faster. However, realize that most 0% intro APR offers are only available for a limited time, usually six to 24 months. Once that introductory period is over, you’re charged regular interest on the balance.
Many offers let you take advantage of the 0% intro APR when you transfer balances within 45 or 60 days of opening your new account. You need to look up the account number for your old balance and provide the information to your new creditor. In many cases, you can do this online. Your new credit card issuer will take it from there, paying off the older balance.
Other balance transfer offers
While you’re most likely to see a balance transfer offer when you open a new account with credit card issuer, sometimes there are other offers.
Some card issuers periodically send out checks you can fill out to perform a balance transfer. Simply fill out the payment information and mail the check, as if you’re making a payment on your higher-rate balance.
You don’t usually get a 0% intro APR, but you can get a much lower interest rate than you already have, so it can make sense to move your balance because you’ll still see more of each month’s payment going toward getting rid of your debt.
What does a balance transfer cost?
Before you decide to move forward with a balance transfer, it’s important to understand the cost. In many cases, you’ll be offered a 0% intro APR. However, there are some offers (especially if you use a check later on) that come with APRs of 2.99%, 3.99%, and 5.99%. These can still be very attractive — especially if you’re struggling to get rid of debt with a current APR of 17.99% or higher.
Often, though, you’ll pay more than just interest fees. Many balance transfers come with their own fees. Usually, the fee on balance transfers is either 3% or 5% of the total amount you transfer. So, when you move $3,000 with a 5% fee, you end up paying $150 just to transfer the balance. In most cases, the balance transfer fee is just added to your balance. If your interest savings are high enough, that fee still might be worth paying.
When shopping around for a balance transfer deal, look for a credit card that will waive the balance transfer fee. If you transfer your balance quickly, some credit card issuers won’t charge a fee, saving you money.
Because you’re charged a lower APR for a limited time, you also have to be aware of the cost once the interest rate reverts to the regular rate. Unless you’ve made serious progress during the introductory period, you could find yourself in a worse position.
How can a balance transfer help you pay off debt faster?
Understanding how a balance transfer can help you pay off debt faster can go a long way toward helping you decide if it’s the right move for you.
Using a credit card calculator, it’s possible to figure out what you’d pay without a balance transfer. Let’s say you owe $3,500 at 17.99% APR and you pay $105 each month. At that rate, you’ll pay $1,387 in interest — and it will take you 47 months to get rid of the debt.
Now, let’s say you get a 0% intro APR balance transfer for 24 months, with no extra balance transfer fee. You’ll have to pay $150 each month, but you’ll be done with the debt in 23 months.
With the balance transfer, you’ve set yourself a deadline, you get out of debt in half the time, and save $1,387 in interest.
Another balance transfer payoff example
Perhaps, instead of a new credit card offer, you receive balance transfer checks that allow you to pay 3.99% APR on your balance for 18 months. You also have to pay a balance transfer fee. You’ll pay $105 for the balance transfer fee, and pay $115 in interest over the 18 months.
So, even though you’re paying $220 for your balance transfer, you’re still saving yourself $1,167 overall, and now you’re out of debt in 18 months. However, to make that work, you have to pay $207 per month. Otherwise, once the promotional period for your balance transfer expires, you’re back to paying 17.99% APR on the remaining balance.
Pitfalls of using a balance transfer
While using a balance transfer can seem like the perfect way to speed up your debt repayment efforts, the reality is that there are reasons not to use the balance transfer.
Not every balance transfer offer is created equal. Let’s say you’re offered a balance transfer for six months with a 5% fee.
There’s a good chance you won’t pay off your balance in that time frame — especially if it includes a balance transfer fee. So, while you can make some headway in that time, once the short introductory period is over, you’re stuck paying the higher interest rate.
In our example, using a $3,500 balance, you’d pay $175 for a balance transfer fee, and then have to come up with $613 a month to meet the terms.
If you can’t make that happen, and instead stick to the $105 monthly payments, according to an online balance transfer calculator, you can end up saving only $244.78 in interest, and you end up taking 42 months to pay off your debt. If your original debt repayment timeline was 47 months, this doesn’t save you much time or money.
If you have poor credit, a balance transfer isn’t likely to help. Most of the best balance transfer offers are made to those with good to excellent credit. The better your credit score, the better your offer.
When you have poor credit, you might actually be better off working out a payment plan with your creditor, or looking into a debt consolidation loan.
Running up new debt
One of the biggest dangers of using a balance transfer in an effort to get rid of debt is the possibility that you’ll get into even more debt.
When using a balance transfer, you need to have discipline. Once you’ve “freed up” money on your old credit card, it’s tempting to make new purchases. However, if you do that, you could end up in even more debt. You’ve got your original debt, which you’re repaying on your balance transfer card, and now you have new debt that you’ve added to the old card.
If you haven’t solved the underlying issues that resulted in your original debt, a balance transfer isn’t likely to help you.
Closing your old credit card
You might want to close your old credit card in order to avoid running up new balances. However, this can have a negative impact on your credit score. Closing an account reduces your debt utilization ratio, and it also reduces the average age of your open credit accounts.
If you’re sure you need to close your old account to get rid of the temptation, make sure that you’re not in a position where you need to apply for credit anytime soon. Your credit score can recover, but it might take a few months.
Tips for effectively using a balance transfer
A balance transfer can be a great tool when used effectively. Here are some basic tips for making the most of a balance transfer.
- Stop debt spending: Before you use a balance transfer, make sure you aren’t spending more than you make each month. Once you have your monthly budget under control, you can transfer balances.
- Reduce your ability to spend on your old card: Paying off the old card can have a positive impact on your credit. However, you don’t want to run up new bills. Consider putting the old card away, putting it in a block of ice, or even cutting it up — without closing the account.
- Get the longest introductory period possible: This gives you more time with a 0% APR, increasing your ability to pay off the debt.
- Create a payment plan for the introductory period: Figure out how much you need to pay each month to demolish your debt during the introductory period. That way, you take full advantage of the 0% APR.
- Don’t use the new card for regular purchases until the transfer is paid off: Avoid using your new credit card until you’ve taken care of the balance. According to law, your payment has to be first applied to the highest interest rate. So, if you’re carrying a balance on your new purchases, your payments are once again going toward interest.
In general, if you use credit cards, it’s best only to buy what’s already in your budget, and what you can afford. That way, you pay off your balance each month without incurring new interest charges.
The bottom line
If you go in with a plan to pay off your balance within the introductory period, and you stick to it, a balance transfer is a smart move. You can pay off debt much faster while saving money on interest. However, before you move forward, make sure that you’re prepared to create a payment plan and that you won’t end up in even more debt than before.