Last week, while at a Farmer’s Market, I met an old friend. Instead of chatting about the price of carrots and cookies, we began talking about finances. I listened to her talk about the worries of being a social worker and how she was struggling with her six figure debt while surviving on her very small salary. I asked her if she had credit card debt. She said, “Yes.” “And how’s your credit score?” I continued. “I think it’s pretty good, last time I checked,” she said. I then asked her, “Have you ever considered a balance transfer?” She didn’t say anything for a moment. She was thinking. Then she asked, “What’s a balance transfer?”
Do the Math
Let’s make it simple. A balance transfer is moving debt from Bank A to Bank B in order to take advantage of a reduced or zero interest rate. Let’s use a hypothetical to illustrate. Let’s say that a person named Jane has $10,000 of credit card debt. Jane’s interest rate is 20% with Blue Bank. Jane also has a good credit score of 700, and she makes payments to her Blue Bank card of $300 per month.
Jane is paying $3,600 a year. Over the next 12 months, she is paying $1,845 of that $3,600.00, in interest. If Jane decides to take advantage of a balance transfer offer, she can move her debt to another bank and reduce her interest rate. Jane looks around for offers.
To entice Jane, Yellow Bank offers a great interest rate or a no interest rate for a set period of time, which could be 6 months to 18 months. Yellow Bank wants Jane’s debt and hopes that if she opens a new credit card account; Jane will keep spending, pay later or do both. But even more, Yellow Bank hopes that Jane still has a balance to pay off at the end of the low-interest balance transfer period. This will give Yellow Bank more return on their risk because Jane will be paying higher interest rates.
Hypothetically, let’s say Jane decides to transfer her Blue Bank balance to Yellow Bank. This sort of transfer happens between two banks, not two bank accounts at the same bank. If Jane moves her Blue Bank card debt to a Yellow Bank card with zero percent interest, she will be able to apply all her payment each month toward her principal.
According to MagnifyMoney’s tool, one balance transfer could save Jane $3,675. With multiple balance transfers, (giving Jane more time to pay off the balance) Jane may be able to save as much as $4,118.
But that’s not all. There are fees and don’t forget the tricky introductory periods. Jane may have had to pay up to 5% to transfer her balance over from Blue Bank to Yellow Bank, which is $183.75. But if you subtract the balance transfer fee from the interest Jane would have paid, Jane will still save about $3,491. Not too shabby.
Tricky Balance Transfer Fees and Introductory Periods
On the surface, a balance transfer looks straightforward, but make sure the balance transfer is truly worth it. Balance transfer fees typically are 3%, 4% or even 5%.
According to UK market at researchers Consumer Intelligence, research indicates that 20% of consumers who transfer card balances, to get a better rate, never pay down their debt. 40% make late making monthly payments, 21% missed payments entirely, 10% pay less than intended and 23% have no idea why they suddenly were being charged interest. A whopping 34% never pay their balances down before they are charged interest, something to keep in mind. It happens to the best of us.
It’s OK to be somewhat concerned about the introductory period. But don’t fret too much about being victimized by a “bait and switch” type banking scheme. The Credit Card Accountability Responsibility and Disclosure Act of 2009 stops banks from luring customers into a balance transfer and then drastically increasing the interest rate months later. Once you agree to a balance transfer at a set interest rate and period, you’re guaranteed the rate as long as you follow the rules. Banks can only cancel your promotional rate if you’re 60 days late with payments. Don’t be late, a cardinal rule.
Some cards have zero balance transfer fees and zero interest introductory rate offers. Look for these. However, these are typically available to people with really good credit scores. We’ll talk a little bit about credit scores, in a moment.
In Jane’s hypothetical situation, if she does nothing, she pays $4,718 in interest over 50 months until the debt is paid off. If she transfer’s once, she pays $1,043 in interest (at 1.7%) and fees over 37 months until the debt is paid off. If Jane transfers her debt multiple times, she will likely pay less in interest and fees over 36 months until her debt is paid off. More often than not, for users with good credit scores, lower “promotional” interest rates more than make up for the fees spent on transfers.
Messing Up Good Credit Scores
Credit scores often drop, depending upon how a balance transfer is accomplished. First, any hard credit inquiry when opening an account is a bad mark on a credit score. But how bad is that bad mark? It depends.
According to Quizzle, a free credit score report website, it is quite probable that every hard inquiry into your credit report will cause a drop of three to five points in your credit score.
Maxine Sweet, Experian’s vice president of public education, told The Huffington Post that recent hard inquiries “account for very few negative points in scoring models and are even less negative within a few months.”
Beware, however, if you are trying to refinance or buy a new home or car, in the near future, it may be best not to ding a good credit score before you finance the big purchase. According to a website called Credible, there are ways to protect your credit scores from the dings received by hard inquiries.
In our hypothetical, if Jane decided that she didn’t want to lower her credit score she would be placing an economic value of about $943.60 on each point she chose not to lose. This doesn’t make sense, if Jane has no intention of refinancing or purchasing a new home within the next 1 to 2 years and she already has good credit. In Jane’s situation, it seems rather penny wise and pound foolish not to take advantage of a balance transfer offer and save the $4,718.00 in interest, over the course of about 50 months.
What to do with Old Credit Cards
It’s also good to know that opening a new account lowers the average age of the overall credit profile, but canceling an old card after transferring a balance really puts a negative ding on the credit scores. That’s not good because again, lowering credit scores might mean higher costs in other areas of life, like renting an apartment, starting a business, purchasing a home, refinancing student loans or trying to buy or re-finance a home.
If a zero interest balance transfer makes good economic sense to you, and you’ve done the math, it’s probably best in most circumstances to keep the old credit card account open, provided new balances are not run up on the card.
Balance Transfer Rules of the Road
- Don’t miss payments — ever.
- Typically, you have only 60 days to complete the transfer. Do this or lose the promotional interest rate.
- Don’t close your old card.
- Don’t use the new card to rack up more debt. In some cases, interest will immediately start accruing on the new purchases (unless there is a 0 percent purchase offer). As a general rule, it is best not to use the card since the goals is to pay off the debt.
- Never use the card at an ATM for a cash advance, especially don’t do it with a balance transfer card.
Finding a Balance Transfer
As a general rule, to qualify for a balance transfer, you’ll need a credit score of 680 or better. According to Nick Clements, co-founder of financial products comparison website, MagnifyMoney, “Banks are looking for ‘high-balance, low-risk’ customers.” This means that your credit card debt is probably less than $20,000 and you always pay on time, and are likely paying the minimum due or just a bit more. If you have had credit for a while, MagnifyMoney offers a free balance transfer calculator for consumers carrying credit card debt.
When to Avoid a Balance Transfer
A balance transfer can be a simple way to slash interest rates and amount of time it takes to pay off debt. But it isn’t necessarily right for everyone. “If you can pay off your debt in six months or less, or can’t afford multiple transfers, than it probably is not worth doing a balance transfer.
If you have debt that you can’t possibly manage, and have little or no hope of paying it off, talk to a good Bankruptcy lawyer now. There are more ways to skin a cat. In other words, your helpful lawyer may have great ideas on how you can become virtually debt free and save most of the things you own, like your car, your savings and your home.
Lower Credit Scores, Now What?
If you have a lot of credit card debt and a credit score below 680, you may not qualify for a balance transfer, but no worries. You can still reduce your interest rates by using a personal loan. Ask your local bank or check out websites like Lending Club or Prosper
These websites allow you to pre-qualify for a personal loan, using soft inquiry rather than a hard inquiry on your credit report. The soft inquiry doesn’t cause a drop in credit score points, but as we mentioned before. The hard inquiry will.
Some Things Just Make Good Sense, Some Don’t
Unless you are in the process of buying or refinancing a home or financing something big, and you’ve got the golden ticket of a 680 credit score or higher, it just doesn’t make good sense to pay high credit card interest rates. Do the math. Figure it out. Even my friend from the Farmer’s Market now has a plan to help manager her debt, even with her meager social worker salary.
If a Balance Transfer Makes no sense and your debt getting way out of hand, you know what to do. Good bankruptcy lawyers typically don’t charge for a first consultation. Find a good bankruptcy lawyer, set up your free consultation and see if a fresh start is right for you.
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ABOUT ME: Attorney Kelly is an attorney in good standing, licensed to practice in both the Federal District and State Courts of Massachusetts and Rhode Island. Her law practice is focused on consumer debt, finance, bankruptcy and District Court matters. Attorney Kelly is experienced in both criminal and civil trial work. On a personal note, Attorney Kelly enjoys writing and other things, like conservation and agriculture.
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