When used in tandem with a broader debt-reduction strategy, balance transfers are a great way to manage uncontrollable debt, and to super-charge debt repayment. However, many individuals don’t look at it for what it really is: A financial tool to more quickly reduce (or eliminate debt), as opposed to an opportunity for racking up “cheaper” debt!
There are also several misgivings about what balance transfers really are, what they can and cannot do, and how one can make the best of them. Let’s take a closer look at some of these questions, and provide you some tips on the best way to use balance transfers.
Eyes Wide Open
To get the best from your balance transfers, you need to enter the relationship with your eyes wide open – fully aware of the consequences of your decision. Here are a few tips to consider for ensuring such transfers work to YOUR advantage, and NOT to that of the credit issuing company:
Tip#1: Less is More!
As highlighted in the intro to this post, the primary reason that you should consider a credit transfer proposition, is if it results in you paying less in interest and debt carrying charges. Therefore, when making the transfer, make sure your higher-interest (compared to the interest payable to the transferred debt) bearing debt is what you transfer, leaving the lower-interest bearing vehicles to deal with outside of a balance transfer.
Tip#2: Beyond Credit Card Debt
To take fuller advantage of credit balance transfers, look beyond just the balances on your credit cards. Most credit balance transfer services (or products) are open to accepting other outstanding debts as well, including car loans and even student loan balances.
In most cases, it may be financially viable to transfer a higher balance (we’ll talk more later about transfer limits) to the new service, as opposed to just your credit card balances. The math may work out in your favour, enabling you to save much more in interest payments.
Tip#3: Be Wary of New Transactions
Once you have made the transfer, and started enjoying the benefits of lower interest payments, don’t take that as a “free pass” to indiscriminately use your new credit facility for new transactions. While you MAY still be eligible for a lower APR, compared to the balances you just transferred, some balance transfer agreements only apply such lower rates to originally transferred balances.
In some cases, new transactions might only be eligible for lower rates during an introductory period. Subsequently, you could be charged an even higher rate than the balances that you transferred!
Tip#4: Know Your Limits
While balance transfers can save you a lot of money if used strategically, as a debt-reduction tool, there are limits to what they can achieve. Before moving forward with a transfer decision, it may behoove you to understand those limits.
Some balance transfer services will assign you a specific credit limit, and allow you to transfer only that amount. Others will cap the amount you can transfer – say, 90% or 95% – of your credit limit. Remember to factor in balance transfer fees into the equation.
For example, if you qualify for a limit of $10,000, and there is a 5% balance transfer fee attached to the transfer, that means you cannot transfer a debt balance valued at the full $10,000. Why? Because the transfer will result in a transferred debt balance of $10,500 (your original $10,000 plus 5% ($500) fee). This puts you above your $10,000 limit!
If there is a cap of 95% to the balance you can transfer, in the above case, you will only be able to transfer 95% ($9,500) or less of your original $10,000 balance. This will result in you transferring $9,450 of your total balance: $9,000 in debt plus $450 in fees.
To make the best of balance transfers therefore, you need to be aware of the limits to the balance you can effectively transfer, and not just the limit you are theoretically allowed to transfer.
Tip#5: Know Your Credit Status
There’s no two ways about it: In the overwhelming cases, balance transfers are a great debt-reduction strategy. However, if you have bad or extremely poor credit ratings, balance transfers may in fact harm you – at least in the short-term.
Firstly, a request for a balance transfer will cause a hard check on your credit status. For most people, even those with less than stellar credit, that won’t make too much of an impact. But if you’ve already had multiple credit inquiries against your credit in recent weeks/months, having yet another inquiry may slightly impact your credit standing.
Balance transfers work best if they result in lowering your overall debt servicing cost. However, if you have bad or poor credit, chances are that you might not qualify for some of the lowest balance transfer rates.
Tip#6: Go with a Plan
The best use of a balance transfer strategy is to leverage it as a means of giving you “breathing room” to pay down your debt. Ideally, if you have a plan to pay off all or most of your balance quickly – well within the introductory period – then you’ll have made the maximum use of this great debt-management tool.
Before you transfer your balance, you should work with a credit counselor to come up with a plan to pay down your debt at the earliest. Use the balance transfer to ensure that more of your monthly payments go towards paying down your principal, and not towards servicing high interest costs.
Balancing Your Decision
While a balance transfer can be an effective tool in your debt-reduction strategy, not all balance transfer cards are created equally. Before you choose one that’s right for you, you should weigh the financial impact of the decision will have on your debt.
One way to do that is to use a Credit Card Calculator to validate whether transferring a balance might be a good strategy. We found that transferring a $10,000 balance to a balance transfer card could not only get you out of debt sooner (12 months versus 24 months), but you could end up paying significantly less ($21.21 versus $1,785.67) in debt.