Can A Balance Transfer Help You Get Out From Under Your Credit Card Debt?
It’s happened to most of us at one time or another. Our credit card balances have mushroomed – seemingly overnight – to unthinkable levels. If you’re starting to wonder if maybe you should’ve immediately tossed all those introductory 0%-interest-rate, preapproved credit card offers into the recycling bin, the answer is probably yes.
Right now, though, you’re scared of what this much credit card debt means for your financial future. And in your hands is yet another pre-approved, 0% Interest Balance Transfer Credit Card offer, and you are wondering if this might just be the answer to your credit card woes... is it?
What Is A Balance Transfer?
Much like it sounds, you take the balance of one or more credit card(s) and transfer it to the shiny new credit card. Your old card will have a zero balance, and your new card will carry that debt for the introductory period without charging any interest.
It makes sense to avoid a year’s worth of high interest credit card payments by transferring to a 0% balance transfer card, if you are certain you can pay it off within the introductory period.
How Does A Balance Transfer Work?
You’ll have to read the fine print on the card you choose (more on that below), but you’ll usually have two choices:
- Follow the online or mobile instructions
- Call the number printed on the card to speak to an agent who will take the necessary steps to transfer the current balance up to your new limit.
While the transactions themselves are fairly quick, you may have to wait until you see your balance disappear from one account and appear in the new one. In the meantime, you’ll have to pay at least your minimum amount due on time.
Why Do Credit Card Companies Offer Balance Transfer Credit Cards?
Credit cards are a modern necessity, and as such we love them and we hate them, but we all understand they are a business. They are simply a loss leader, or a cost of acquiring new business.
A 0% introductory interest offer is an excellent example of a loss leader. Think of how some grocery stores offer below average prices on certain items. They are losing money on those items, but making more money overall because they can charge a little more on the other items you’ll buy once you’re in the store.
How Do Credit Card Companies Make Their Money On 0% Interest Balance Transfer Credit Cards?
Credit card companies know they’ll make money from swipe fees at the points of purchase, balance transfer fees and, later, at interest rates that may be much higher than your original cards charged.
Credit card companies are looking at their long-term business model. If you hold onto a credit card over decades, the loss they took with that “free” first year is a small price to pay for your continued business.
When 0% Isn’t $0
Of course, even that first year isn’t free. You’ll find that the 0% interest does not mean $0 in fees.
If you think a balance transfer credit card is the right solution for you, these are some things to watch out for:
Balance Transfer Fees
Let’s say you owe $7,000. (That’s the average amount of debt carried by U.S. households.)
Now let’s say you find a balance transfer credit card with an introductory offer of 0% interest. You're thinking you’ll transfer the balance from the old card to the new and then pay it off without incurring any charges. (That probably won’t happen, as we’ll discuss below, but the plan makes sense.)
Here’s the problem. The first thing you’ll have to do is pay a hefty balance transfer fee, usually between 3% – 5% of the amount transferred or a flat rate of $5 – $10, whichever is greater. Your $7,000 transfer will cost you between $210 – $350. You’ll probably pay that with the new card, meaning you’ll immediately start paying interest on it.
Another thing to look for is whether the card charges an annual fee. If it does, know that – as in the case of the balance transfer fee – it will be charged to your card and then will accumulate interest charges as well. Annual fees are less common with the best credit cards, but if your credit is shaky, you might not be eligible for those.
Introductory Period Length
Most 0% introductory periods last for 12 months. Some cards offer a longer introductory period, usually 15 months or 18 months, but these are usually reserved for those with excellent credit.
Let’s say you plan to pay off your balance during the introductory period, without incurring any new charges. To pay off that $7,350 balance (the average household credit card debt + the balance transfer fee) and avoid all interest, you’ll have to make monthly payments as follows:
Before you go this route, ask yourself this and answer honestly: If you got into debt in the first place because your expenses exceed your income, what will happen when you try to put an extra $400 – $600 into paying down your credit card debt? Credit card companies know it’s unlikely that you’ll be able to swing a full payoff, no matter your good intentions.
At that point, having failed to pay off the balance during the introductory period, you’ll have to start paying your new card’s APR.
Annual Percentage Rate
If you’re looking at credit card offers, you may have noticed the term "annual percentage rate," or APR. That’s the true cost of the credit, taking into account interest rates, fees and any other charges. Knowing the APR allows you to compare offers on an apples-to-apples basis.
Even though interest rates are low and probably will stay that way for the foreseeable future, credit card APRs tend to start at around 13.99%. That rate is reserved for those with excellent credit. In contrast, the minimum APR for a Rocket Loans™ personal loan for debt consolidation may be lower than the credit card rate for those with excellent credit.
Is Using A Balance Transfer Credit Card A Good Idea?
Maybe. It all depends on the nature of your debt.
Good Idea: Your Debt Is A One-Off
It’s an easy way to borrow money for free on a short-term basis (as long as the introductory period lasts). If you’ve encountered an unexpected budget-breaking expense that’s spiked your balance – say, for example, an emergency auto repair – and you’ve already figured out how you’ll repay it, there’s no reason not to avail yourself of the free interest offer.
Bad Idea: Your Debt Has Become A Way Of Life
In contrast, if your balance is creeping ever upward because you’re relying on credit cards to fill income-to-expense gaps in your budget and you’re juggling multiple balance transfers, you may be flirting with ultimate financial disaster. It’s an exhausting, and ultimately unsustainable, way to live.
And when you’ve tapped out your ability to get more balance transfer credit cards, your new cards’ less attractive permanent rates will begin accelerating your debt levels toward new dizzying heights.
A quick way to see if your debt is out of control is to check your debt-to-income ratio, or DTI. To find this value, add up all your monthly payments, including rent or mortgage, then divide the total by your gross monthly income. If your DTI is less than 36%, you’re in good shape. If it’s over 36% but below 45%, you should start thinking about reducing your debts. If it’s over 45%, you need to start doing so urgently.
Personal Loans: An Alternative To Balance Transfer Credit Cards
There is an alternative to the balance transfer treadmill. Consider a debt consolidation loan to help you solve your financial pinch.
What Are Debt Consolidation Loans?
Debt consolidation loans are a type of personal loan that allow you to transfer your credit card debt to a personal loan. This means your monthly payments will not change from month to month, and you will be paying simple interest instead of compound interest. With a debt consolidation loan, you’ll only ever pay interest on your principal.
How Do The Monthly Costs Of A Debt Consolidation Loan Compare To Balance Transfers?
A debt consolidation loan gives you the opportunity to choose the length of your loan term, instead of having the credit card company impose one on you through an introductory period. If you have $7,000 in debt, you can choose your monthly payment accordingly:
You can see that choosing your own term will have a major impact on your ability to put together a sustainable budget.
What Are The Advantages Of Using A Personal Loan For Debt Consolidation?
If you’ve lost control of your spending, there’s a lot to love about using a personal loan for debt consolidation.
Structure And Debt Discipline
A personal loan is an installment loan. This means that every month you will pay the same amount – and that payment represents the simple interest you are being charged and some of your principal.
With credit card debt, your monthly minimum payment is interest only, and the interest is compounded every day and added to the principal, so that the next day’s interest charge is larger than the day before. If you can only make the minimum payment from month to month, you’ll never get rid of the principal amount of your debt.
Cost Of Debt
Let’s say you carry the average credit card debt of $7,000 for 5 years. Let’s also assume you have excellent credit because you always make those minimum payments but never much above that to chip away at the principal. At the end of those 5 years, at an interest rate of 14% on your credit card, you will have paid total interest of $7,094.38 and still have a $7,000 principal.
If you had taken out a 5-year loan at 7% interest, you would have paid $1,316.50 and, at the end, had a zero balance.
Regular and on-time payments will go a long way toward both improving your credit.
A debt consolidation loan, however, won’t help you in the long term unless you change your spending habits and begin to stick to a monthly budget. If you’re having trouble seeing your way to a responsible spending plan, consider asking a financially responsible friend or family member for help, or seek out the help of a credit counseling service.
Knowing your options if you find yourself in problematic credit card debt is important. If you are worried about your debt, and believe the structure, lower interest costs and predictability of a debt consolidation installment loan will help you get a handle on your monthly budget, apply for a loan today.
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