Money Smarts Blog

"Interest free for 12 months with your credit card balance transfer."

You’ve probably received a similarly enticing offer. It may go in the trash or circumstances in your life may lead you to pause and consider the offer. A credit card balance transfer certainly has its place – if you’re smart about it.

Interest Rates

Do you have a plan to pay off the transferred balance within the promotional period? If not, does the new card have a lower interest rate than your current debt to make the transfer worthwhile?

Good: If you answered yes to either question, a balance transfer could make sense, especially if you can refrain from making new purchases on either card AND pay the minimum balance (or more) each month.

Bad: If you answered no to the questions above, whether it’s 6, 12 or 18 months later, that magical interest-free promotional period will end. You could find yourself buried in even more debt than you started with, especially if the new card included a balance transfer fee (typically 3% - 5%) or had a higher annual percentage rate (APR).

Ugly: Worse, you also continued to use your old card after giving it a shiny clean slate. Now, not only do you still have a balance on the new card, you’ve dug yourself into deeper debt by continuing to accrue interest on the old card.

Credit Score

How a credit card balance transfer impacts your credit score is strongly based on what the balance transfer does to your utilization rate – the comparison of your balances to available credit. Utilization rate accounts for 30% of your credit score.

Wondering what your utilization rate is? Grab a calculator and follow these easy steps:

1. Add the balance owed on ALL of your credit cards.
2. Add the limits for ALL of your cards.
   No cheating. These first two steps need to include all credit cards. Even if the card does not currently carry a balance, it needs to be included due to its available credit limit.
3. Divide the total existing balance (Step 1) by the total credit limit (Step 2).
4. Multiple by 100 to see your ratio as a percentage.

Most experts advise keeping your utilization rate below 30%. Your credit score is impacted by both your overall utilization rate, as well as the utilization rate on each individual card. When this rate is low in both areas, you’ll likely increase your credit score.

Good: When doing a credit card balance transfer, you may notice an initial decrease in your credit score because you’re increasing the utilization rate on a single card. However, as you continue to pay down the transferred balance, the utilization rate will decrease and your overall credit score will increase over time.

Bad: New credit makes up about 10% of your overall credit score. Each time you apply for a new card, a hard inquiry is involved. A balance transfer adds another hard inquiry. If you’re consistently taking advantage of credit card balance transfer promotions and opening new lines of credit, the increased inquiries will cause a dip in your score and you’ll be seen as a higher risk to lenders.

The age of your credit history accounts for 15% of your overall credit score. Longer credit history tends to increase a score. Therefore, a balance transfer between existing cards won’t likely impact your score in this category – but each new card opened will decrease your average age of credit.

Ugly: Life happens. You may be late or miss a payment on your new card. This may void your eligibility for the promotion and could also involve penalty fees. It also means that interest rates are back on the table. So, you’ve taken a hit on your new credit, decreased your age of credit and increased your utilization rate without enjoying the benefits of the 0% interest balance transfer. 

Credit Card Consolidation

Credit card consolidation may also lend to the appeal of our fictional promotion.

Good: If you have a balance on multiple high interest rate cards, it may simplify your financial life to consolidate to a single low interest rate card. I know I personally feel more in control of my finances when I just have one credit card bill to pay each month.

Bad: Credit card consolidation merely simplifies your repayment process. It neither reduces nor eliminates debt. If you’re not paying down the debt, you haven’t really improved your situation much.

Ugly: Some may fall prey to credit card consolidation companies who charge a fee for services, landing most in more debt.