You get the envelope in the mail and it’s hard not to open it right away. After all, the offer from the bank has “0% interest preapproved credit card” printed all over it. After all, you are paying really high interest rates on that one credit card you have. Should you transfer your balance and save money? It’s a no-brainer, right?
Not so fast, as there other considerations to take into account – including the potential impact to your credit score. But the good news is that when managed correctly and under the right circumstances, a balance transfer can save you money AND improve your credit score!
First off, before you jump at the chance for a balance transfer when you get an offer, realize that the 0% interest rate only applies to an introductory period, maybe for one year. Read the fine print because after that period, the interest rate most certainly go up – and often pretty high. In fact, cards with 0% introductory rates often have much higher interest rates over time than a corresponding credit card without that initial offer.
But it sure is an effective way to get a consumer’s attention!
Also, these 0% cards usually come with a fee. In many cases, the fee to take advantage of their offer is 3% of the total balance you’re transferring to this new card. So if you want to take $10,000 in existing credit card debt and transfer it over to your new 0% card, that will cost you $300 right from the get-go!
Before you sign anything, pay close attention to these balance-transfer fees, the length of the introductory 0% interest rate, and what the rate will be after that.
But it’s not all negative because if you do get approved for this 0% transfer, you very well might save some money in the short term.
For instance, if you were paying 15% for that $10,000 account balance (for illustration purposes) but you’re able to pay 0% interest for the next 12 months, you’ll save about $831 in interest (minus the initial fee!).
So why do banks make these offers if you’re saving so much money? They know that eventually, the interest rate will go up after the introductory offer expires, and you’ll be paying A LOT more in the long run.
Also, people who “play the shell game” by moving their credit card debt around like this often are serial users of their credit cards. So the bank knows that you’ll probably spend and charge even more with their new card – which WON’T be subject to the 0% introductory offer if it only applies to balance transfers.
How will a balance transfer impact your credit score? Believe it or not, your credit score may actually go up in some cases.
Remember that a good portion of your credit score is calculated based on the amount of debt you owe compared to your total available balances, called your credit utilization ratio. In fact, 30% of your FICO score is determined by your utilization ratio.
What happens when you get a new 0% introductory offer and transfer the balance from another card? Ostensibly, you have kept the same amount of total debt (just transferred it) but have increased your total available credit, which improves your ratio (lower debt-to-balance).
As a general rule, it’s recommended that you keep your utilization ratio at or below 30% for all credit and revolving accounts. So to use an overly-simplistic example,
Scenario A
You have one credit card with $10,000 debt and a $15,000 available balance. Therefore, your utilization ratio is 66.6% – way too high, so your credit score is probably suffering.
Scenario B
But after you open up a new credit account with a 0% introductory offer and transfer your balance, you still have $10,000 debt, but now at least $25,000 available credit ($15,000 for the old account and $10,000 or more for the new account). That means your utilization rate just plunged to 40%. It’s still not ideal, but it’s a vast improvement – and FICO’s scoring algorithms will reflect that.
There are, however, a couple of other considerations before you run out and start applying for 0% balance transfers and think that it’s great for your credit.
Before this new creditor approves your balance transfer and gives you new debt, they’ll surely do a hard credit check, which can cause your score to drop 3-5 points in the short term. That may not be a big deal, but you don’t want to start applying for credit cards or other revolving or retail debt in bunches, as it’s a clear sign of irresponsible credit use, and credit inquiries account for about 10% of your score.
Also, you may be maxing out your new credit card if the total available balance is taken up by the amount you transferred. Or, if the new balance is higher and you still have available credit, patterns of consumer behavior dictate that you’ll probably spend more on the new credit card AND start spending on the old card again!
What about if you pay off your old credit card completely and close it out once the balance is transferred? That could actually hurt your credit score even more – both because you just sent your credit utilization ratio out of whack, but also because you just erased a seasoned history of on-time payments (assuming that’s the case). Since credit history accounts for about 15% of your FICO score, closing an old credit account will probably really hurt your score.
Of course, each situation is different and FICO’s credit scoring algorithms are complex and not 100% predictable, but now you know the pros and cons of transferring a credit card balance, even if that 0% introductory offer looks so enticing!
Feel free to contact us if you’d like a little bit more advice and help based on your credit situation.
