I was asked by a friend if balance transfer really works. In short, “yes”. But there are some caveats.
First, you may be wondering what a balance transfer card is and why anyone would want one.
A balance transfer card is simply a credit card that you sign up for, and assumes the full current balance of your credit card. Say you owe $13,452 on your credit card. You signed up for a balance transfer card and now you owe zero on your credit card. Just like magic. Except for one important detail; You now owe $13,452 on the new card.
OK, so why would you want a card like that? On your old card, you probably paid over $200 per month in interest payments. That’s because interest rates tend to be in the 16 percent range, unless you have a bad credit score (in which case you could pay a lot more).
But on a new card, you might pay as little as $20 per month or maybe even…none! That’s because balance transfer cards are specifically designed for people whose credit card balances are running up and need drastic interest rate relief.
OK, so now you’re probably asking, “Who wouldn’t want a card like that?” Well, I did mention a few caveats. So before you apply for a balance transfer card, it would be nice to be armed with this information.
Balance transfer rates are temporary. When you sign up for a balance transfer card, know that the low, low rates will only last for six months, or twelve or fourteen months, or sometimes eighteen months. Temporary relief is better than no help, but other factors are involved.
ACTION: Look for the card with the longest grace period.
The advertised “0% APR” may not be zero percent for you. If you have a bad credit rating, there’s a good chance you’ll end up paying interest. The abbreviation APR stands for “annual percentage rate,” but it’s often advertised as “typical APR.” This gives issuers the flexibility to cover their backs for high-risk customers – especially high-risk customers who come in with them already with deep credit card debt.
ACTION: Make sure you pay zero percent. If not, it’s time to call your credit report to see what can be fixed.
Regular APR may be higher. What happens if you switch from a credit card with a 16 percent interest rate to a balance transfer card with a zero month 12 APR and a regular rate of 18 percent? Well, if you have no additional debt on your card and don’t pay it off, by holding on to your $13,452 debt, you will now be paying an additional $20 or more per month. You’ve got a delay, a reprieve, but your long-term prospects are worse than ever.
“Once you’ve been approved for a balance transfer card, it’s very important that you immediately apply the money you would have paid in interest on your old card to repay the principle on your new card,” said Chris Mettler of CompareCards. com, the company that actually signs up people for balance transfer credit cards. “Your whole focus should be on reducing your total debt before full rate starts at the end of the introductory period. If you do that, balance transfer cards can be very effective indeed.”
ACTION: Look for a card with a regular APR equal to or lower than your current card.
Balance transfer cards usually come with an upfront fee. This fee is usually three to five percent of the transferred balance. Yes, I know it sounds harsh, but that’s what one bank does to reduce the risk of taking on debt you have at another bank. If you let debt sit on a new card, this fee alone negates any gains you might have made. But if you pay down debt aggressively, these fees can be rewarding.
ACTION: Shop for balance transfer cards with the lowest transfer fees available.
There may be an annual fee. This may be a minor consideration, but some balance transfer cards have an annual fee. If you saved thousands of dollars and had to pay $50 per year for the privilege, you might find it worth it. On the other hand, if the savings are only $500, but the annual costs are $150, you may want to reconsider.
ACTION: Check the annual fee before applying for the card.
Another caveat. Ask questions about what actually applies to a zero APR. This may only apply to your transferred balance and not to new purchases. Or maybe it only applies to new purchases and not to the balance you’re transferring. It may or may not apply to cash advances (and it may or may not matter to you). And some credit cards have been known to charge “capitalized interest”; if you do not pay off the entire balance you transferred during the promotion period, you will still be owed all the interest you have will pay.
ACTION: Ask questions, read the fine print… and use your calculator.
Jeremy Bowles, a freelance writer and part-time video-game addict. Jeremy has worked in a number of different positions for two different banks over the years. She advances her experience-based personal finance advice in articles like this one to help people understand their options for better managing their money.
