Balance Transfer Pros & Cons
When you are swimming in multiple credit card debts, the offer of a low-interest balance transfer can seem like a life vest. Many banks will offer a 0% interest balance transfer just to simply move your debt to their bank. While this offer seems like a sweet deal, it also comes with several risks. The biggest risk being that the 0% interest is only for a limited amount of time. Once the term expires, the interest rate skyrockets to 20% or higher. Before you commit to a transfer, you should consider all of your options for repayment and understand the terms of the transfer contract. Check out our recommendations for when and when not to utilize a balance transfer.
A balance transfer would be beneficial for you if:
- Your Debt Is Manageable. By manageable, we mean that your debt is less than 30% of your take home pay. If your debt burden is over 50% of your monthly salary, it is unlikely you would be able to pay it off before the term ends.
- You can mathematically make the minimum payment, ideally more, and pay it on time, every single month. If you miss a payment, you can be hit with very expensive penalties. These penalties are likely more severe than the credit card with the original debt.
- You have enough self-control not to use or withdraw cash on the credit card the balance was transferred to.
- Your credit score is average or better than average. Every time you apply for credit, your credit score will take a small hit. You need to proceed with caution so that you don’t further damage your score. You can do a pre-application by using a balance transfer eligibility calculator, which can give an expectation of the bank options you may have without affecting your credit score. Also, note that your credit score will determine the length of the 0% term. Banks will often advertise ‘up to’ 15 months, 20 months, etc. The ‘up to’ is based on your score. Generally, the bank will offer a longer term the higher the credit score.
- You intend to transfer the balance again or close the account at the end of the term. Remember that once you reach the end of the term, the interest rate rises steeply, so if you have remaining debt, you should plan to transfer the balance again. If you do pay off the balance, close the account and only rely on a credit card with a lower interest rate.
Conversely, a balance transfer would be more risky if:
- You consider the transfer as a means to get rid of debt. Often times, people will feel a sense of accomplishment when they consolidate debt using a balance transfer. One might say, “I got rid of my Visa debt.” This thinking often leads debtors to continue spending. Understand that you have not eliminated debt; you have simply move it. A 0% balance transfer is a tool to manage debt. It is not the solution to get rid of debt.
- You physically cannot pay more than the minimum payment. If you simply pay the minimum, you will find that you still have debt at the end of the term. You have to pay more than the minimum to eliminate the debt.
- You have a low credit score. As aforementioned, applying for the transfer will lower, only slightly, your credit score. But, a low credit score will also generate a shorter term to pay off the debt.
- You don’t have financial discipline. Again, in order to pay off the debt before the term ends, you can’t keep spending. A balance transfer makes the urge to spend even more tempting because the bank will often increase your credit limit. For example, if you have three maxed out credit cards with balances of £1200, £1500, and £2000, the lender may consolidate the £4700 owed onto a credit card with a £6000 limit. This may entice the borrower to think they now have another £1300 available to spend.
- You have smaller debts that can be paid off in six months or less. If you are looking at several small debts, you may be better off using the debt snowball approach. Then you can avoid all of the risks associated with a balance transfer.