6 Hidden Dangers of Credit Card Balance Transfers
The credit card balance transfer is often touted as one of the best ways to tackle credit card debt. You move your high-rate balance to a new card with a 0% introductory rate, and your payments aggressively reduce your debt. (See also: Balance Transfer Basics)
Before you get too excited, though, it's a good idea to step back and evaluate your situation. Credit card issuers wouldn't offer such a screaming deal if there wasn't something in it for them. Here are six of the "hidden" dangers associated with balance transfer offers.
1. The Transferred Balance Is Usually Credited First
True, the Credit CARD Act of 2009 requires credit card issuer to apply your payment to the highest-rate balance first. But there is a loophole: Issuers can allocate the minimum required payment in any way they want.
Say you have a 0% APR balance transfer on a card amounting to $1,500, and you make a few new purchases at the rate of 19.99% totaling $500. Your minimum payment is $60, and you decide to pay $100, as part of your debt reduction strategy. (See also: Which Debt Reduction Strategy Is Right for You?)
The credit card issuer has the option to apply the $60 of your minimum payment toward the high rate purchase or to the low rate balance transfer. Of course, the issuer will apply all of the minimum to the 0% balance, then apply what's left — $40 — to the high rate purchase balance, according to the law. This keeps the high rate balance on the account longer, earning the card issuer more interest.
To avoid this, don't use the card to make additional purchases, especially if there is no introductory purchase APR. Be aware that credit card issuers divide up your balances. Your purchase APR is different from your balance transfer APR, and both are different from a cash advance APR.
Your balance transfer card should be used exclusively to pay down debt faster, and you don't need high-rate purchases mucking up those efforts. (See also: Best 0% Balance Transfer Cards)
2. Post-Introductory APRs and Tricky Terms Snare a Majority of Transferees
Once the 0% APR period is up, your balance is subject to the regular APR — which is often higher than you might see with other cards. Often, these cards come with rates as high as 21.99%.
As long as you pay off your card before this higher rate slams you, you're fine. However, research indicates that 34% of consumers don't pay off their balances within the introductory period.
On top of that, 20% of balance transferees don't get the entire introductory period because they violate some term. If you pay late, or don't make the minimum, your intro rate is revoked and you revert to a higher rate. Add these groups up, and 54% of consumers who take advantage of balance transfer offers don't reap the reward of eliminating their debt. Worse, they find themselves with balances on cards with the highest rates.
If you do transfer a balance, make sure you have a plan to pay it off within the introductory period and do not run afoul of the issuer's policies. (See also: How Much Does Your Credit Card Cost You?)
3. Balance Transfer Fees Eat Up Savings From Transferring
It's so easy to get excited about a balance transfer deal that you forget to look at the balance transfer fee. However, a balance transfer fee can significantly reduce the effectiveness of your balance transfer. Balance transfer fees range from 3% to 5% of the transferred amount. This fee is often added to your balance — and it may or may not be considered part of the 0% APR — check the fine print! (See also: Use the Schumer Box to Decipher Credit Card Offers)
Before you transfer your balance, make sure that the interest savings outweigh the balance transfer fee.
4. Rewards Can Entice You to Spend More
Watch out for balance transfer cards that also offer rewards. The problem here is that many of the cards that offer rewards programs and introductory balance transfer rates don't offer an introductory rate on purchases. So you are encouraged to make purchases to get the rewards. However, those purchases come with interest charges that can offset what you save with your balance transfer. Add in a balance transfer fee, and your balance transfer can cost you even more.
Be clear about your objectives before you use a balance transfer card. If you want to get rid of debt, you don't need the rewards program. Instead, devote yourself to paying off the balance before the end of the introductory period, and avoid making new purchases with a credit card.
5. Your Credit Score Can Drop
Depending on how you accomplish your balance transfer, your credit score can drop. First, the hard credit inquiry can ding your score a bit when you open an account. Plus, your new account lowers the average age of your credit profile. If you cancel your old card after transferring your balance, you could end up with a higher credit utilization, which is a negative in the credit scoring algorithm. A lower credit score can mean higher costs in various areas of your life. (See also: Surprising Ways to Hurt Your Credit Score)
When transferring a credit card balance, make sure that you are careful to keep your old account open (as long as you have the discipline not to run up new balances).
6. Other Fees May Be Lurking
Pay attention to other fees that might be charged by the credit issuer. There might be a higher late payment fee on your new card, or there might be an annual fee. These types of fees reduce the effectiveness of your 0% APR balance transfer.
Bottom Line: Pencil It Out Before You Make the Transfer
Make sure that you run the numbers before you transfer a balance. For example, transferring $10,000 in debt will cost $300–$500 in fees alone. The same debt left on a 15.99% card will incur $1300 in interest, assuming it is paid off in 18 months (and much, much more if it isn't). That's still a significant savings of $800–$1000 in just 18 months, but given the other hidden risks, you should verify that transferring your balance really will benefit you, and that you really can pay off the debt in a timely manner.