Do you have multiple credit cards?
The average U.S. household has a credit card debt of $6,006. These figures may seem high or low depending on who you ask. However, if you’re someone who is having trouble making repayments, credit card interest can quickly become overwhelming.
Credit card debt is often considered as a bad debt because it diminishes your wealth over time. Although, in the context of a balance transfer, this type of credit card can be an effective way to reduce your repayments. In this article, we’re going to explore what a balance transfer is, how it works, and the fine print you should always consider. This may help you compare and make an informed decision.
What Is a Balance Transfer?
Let’s start off with the basics by first defining what a balance transfer is.
A balance transfer is when you move one debt into another debt. For example, let’s say you have a Mastercard, American Express and Visa credit card–all from different banks. Your Mastercard has $2,000 owing, your American Express has $3,500 owing, and your Visa credit card has $3,000 owing.
Doing a simple calculation, you owe a total of $9,500. But this is not the complete story.
This is because each credit card has its own interest rate (also called annual percentage rate – APR) and these can typically vary from 12% to 24%.
For the sake of this demonstration, we are going to make the following assumptions:
- You will make a minimum repayment of $100 per credit card per month and cease using them altogether
- Your Mastercard has an APR of 15%
- Your American Express has an APR of 19%
- Your Visa credit card has an APR of 12%
- All your credit cards have zero annual fees and the minimum repayment allowed is 2 percent.
Using a credit card repayment calculator, it will take you 3 years (36 payments of $300) to be completely debt-free. That is, paying $10,668 in total where $1,168 is going towards the interest.
This is where the concept of a balance transfer can help you save money paid towards credit card interest.
A balance transfer is the process of consolidating these debts into one single repayment plan. Using the previous example, instead of paying three different interest rates, a balance transfer will combine them under one single annual percentage rate where the interest rate is lower than those from your existing Visa, American Express, and Mastercard credit cards.
The goal of a balance transfer is to reduce the amount of interest paid by as much as possible. That is, instead of paying $1,168 in interest, a balance transfer credit card could reduce this significantly provided that you make the monthly repayments during the promotion period.
What Is a Balance Transfer Credit Card and What Are Its Advantages?
A balance transfer credit card is a credit card that allows you to transfer an amount of money (often up to 80% of the card’s credit limit) from one credit card to another.
In terms of benefits, a balance transfer primarily has two:
- Reduce the amount you end up paying in interest.
- Help you improve your credit score.
Paying interest does not add to your personal wealth. It does the exact opposite and this is why credit card debt is seen as a bad debt. The whole point of a balance transfer is to allow you to repay the principal amount while reducing the amount paid towards the interest.
By doing this, you can also improve your credit rating.
“A credit score, also known as a credit rating, is the number that represents your financial history. Banks and other lenders use this score to indicate your reputation as a borrower, determining your creditworthiness to pay them back” – Clearscore.
While your credit score may not seem important to you right now, ignoring it can prevent you from gaining access to favorable loan terms in the future. There are many free ways to access your credit score–Credit.com is one way.
The Next Steps
- Review every credit card that you have and tally up the balances owed.
- Do a monthly budget to get an honest account of your spending habits and compare this with your income. This is so that you can be realistic about what you can afford to repay in a limited time.
- Search for “balance transfer offers” or “low APR credit card” and see what is available to you.
- Speak with a licensed financial advisor to get tailored advice.
- Apply for a balance transfer.
- Once approved, cancel your existing credit cards.
- And most importantly, stick to the payment plan and never miss a payment and don’t use the balance transfer credit card for any spending.
[Related Read: How To Make A Financial Plan]
Understand The Fine Print
As with any financial product, read the fine print and seek professional advice. When it comes to balance transfers, if you don’t pay off the balance you transfer within the stated time, it may end up costing you more. And that’s the exact opposite of what you’re trying to achieve. Similarly, if you start making purchases with the balance transfer credit card, you’ll have to pay these off first and with many cards, the APR can exceed 20% p.a.
In closing, here are a few things to look out for when shopping around for a balance transfer credit card:
- What is the introductory APR?
- How long does the introductory APR last?
- What is the maximum balance transfer amount? Quite often, you can only transfer up to 80% of the card’s credit limit.
- What’s the balance transfer fee? Usually a 1-3% fee applies.
- Is there an annual fee?
- What’s the minimum repayment due each month?
- Are there any conditions of the balance transfer that apply to your existing credit card debts?
Learn more: Credit Cards with No Annual Fees
- Credit card debt is calculated daily and this can quickly add up even if the APR doesn’t seem high.
- A balance transfer is when you move one debt into another debt. This is done to reduce the amount of interest you will pay by taking on lower APR.
- Some balance transfer credit cards offer 0% APR but often incur a one-off transfer fee.
- Don’t continue to use your credit cards after doing a balance transfer–you can keep it open even if you don’t plan on using it.
- Paying off your credit card debt quickly and consistently will improve your credit score.
This article originally appeared on Credit.com and has been republished with permission.
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