In theory, a balance transfer credit card is a great idea for anyone wanting to reduce the amount of interest they pay on outstanding credit card balances. When used correctly, these cards can seriously help some people to pay down their debts quickly and get back some control over their financial situations.
However, if you don’t fully understand how balance transfer cards work, you could find you end up in a worse financial situation than the one you started at.
Using Balance Transfer Credit Cards to Reduce Debt
If you’re already paying a huge interest rate on your existing credit card debt, you can definitely benefit from a balance transfer card with a low introductory interest rate.
Ideally, you would transfer the balance from your old account over to your new account and you’d instantly be paying much less interest on the amount you owe. This effectively means every payment you make goes directly towards paying off your debt levels instead of covering interest costs.
Unfortunately, there are many customers who find that it’s not always as easy as it looks, especially when you add in some of the pitfalls.
Things to Watch For
Before you apply for any balance transfer offer you see, take some time to do a bit of comparison shopping. Far too many people believe that a card offering a 0% interest rate for 6 months will be the best option for them. After all, you can’t get any lower than zero interest.
What those people forget is that 6 months isn’t a really long time, and at the end of that introductory period the low interest rate expires to be replaced with a much higher purchase rate.
So if you haven’t repaid your entire outstanding balance before the end of those first six months, you could find your interest bill goes right back up to where it was before you started.
Take a moment to work out how much you’d need to repay each month in order to reduce your debt down to a zero balance before the introductory period ends.
Example: if you owe $2,500 on your credit card debt, you’d need to pay at least $417 per month in order to pay it all off.
Opt for Longer Term
Not all balance transfer cards are set over a short term. In fact, there are some that extend for up to 18 months. If you know your budget won’t allow you to repay your entire balance before the low interest rate ends, work out whether a longer term card might be right for you.
You will find that the interest rate charged on longer transfer offers will be a bit higher, but in the long run you’ll be saving far more money.
For example: if you owe $2,500 and you opt for a balance transfer deal at 2.9% for 18 months, this makes your monthly budgeting much easier to deal with. You’d need to pay around $155 per month for those 18 months to repay your entire balance and not be affected by it reverting to a higher rate.
Always Check What the Rate Will Revert To
When the low rate offers end on balance transfer cards, the rate your account reverts to will often be much higher. It’s important you take the time to check how much you’ll end up paying if you have a balance left at the end of the term, or you could end up paying more than you need to.
Wherever possible, try to find an account that reverts to a competitive purchase interest rate.
Do the Sums
Of course an interest rate of 2.9% looks like you’re paying more than if you’d opted for the cheaper 0% option. But there are times when the higher rate can save you money. The key is to do your comparison shopping and then do the sums before you make your decision.
Here’s an example of a credit card balance of $5,000 that takes a customer two years to repay completely:
| Balance Owing | Introductory Rate | Standard Purchase Rate | Introductory Term | Total Interest Paid |
| $5,000 | 0% | 16.47% | 6 months | $508 |
| $5,000 | 2.9% | 13.47% | 18 months | $192 |
In this example, it shows how opting for a slightly higher rate over a longer term that reverts to a more competitive standard purchase rate can actually save you money.
Beware Your Balance Transfer Card Usage
One other major point to keep in mind with balance transfer credit cards is the payment hierarchy applied to these accounts. This means that if you have a really low balance transfer interest rate applied to your account, don’t be fooled into thinking you can just use that same card to pay for a purchase.
Even if you think you’ll put that money you spent right back onto the account again next pay day, banks have different ideas.
They call this a payment hierarchy, and it means they allocate your repayments towards paying off whichever debt is charged at the lowest interest rate first. This leaves the debt amounts incurring higher interest levels unpaid until you clear those other balances first.
Here’s how it works: Assume you spend $200 on a purchase today and you put that money straight back into your credit card account tomorrow. That money won’t go towards paying off the amount you spent on the purchase.
Instead, it will be applied to the balance amount with the lowest interest rate – in this case, your balance transfer amount.
So that $200 will remain unpaid for until the amount you originally transferred over is paid off first. During that time, that little $200 amount will be attracting the standard purchase interest rate the whole time.
It’s important that you stay disciplined with your credit card usage in order to get the most benefit out of it. If you really want to pay for a purchase, use a different card, of you’ll end up paying more interest than you need to.
Timothy Ng lives, breathes, and sleeps personal finance! Check out his in-depth guide to doing a balance transfer where he answers everything you need to know to reduce your credit card debt.
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