Balance transfer promotions are essentially a marketing ploy by credit card issuers to attract more borrowers. If they can lure you in with an irresistible zero or low interest transfer offer, they stand to generate more revenue from you as a card user. While balance transfers can help you to pay down high interest debt and improve your credit picture, they can also lead to bigger debt problems for people who struggle with debt due to overspending. If you are considering a balance transfer offer, it is important to understand the how it works to avoid any problems.
The Anatomy of a Balance Transfer
When a person receives an offer to transfer a balance at a low introduction rate, the terms usually include an expiration after which a new rate is applied to the transferred balance. The promotional period can last between six and 18 months with most promotions lasting 12 months. Once the transfer is made, the cardholder makes payments towards the balance which may not include any interest if it has zero percent promotional rate. However, when new purchases are made, the issuer usually charges its normal interest rate on the new balance.
Balance Transfer Fees
Most banks charge around 3 percent of the balance being transferred (i.e. on a $5,000 transfer the fee would be $150). On large transfers, that could amount to a significant chunk of new debt. The more competitive cards will cap the fee at somewhere between $50 and $100.
The other fee to look for is the annual fee which can range from nothing, to as high as $100 a year. Obviously, you want to avoid the cards with high annual fees. There are enough issuers willing to compete for your money with low or no annual fees.
Avoid the Rate Trap
What trips most people up is the different rates applied to different balances. Your transfer balance may be charged the promotional interest rate, but any new balance you create from additional purchases may be charged a higher rate. And the double whammy is that all payments are applied to the low interest balance, so the high interest balance continues to accumulate debt. Again, the competitive issuers are attracting more customers by applying the same low rate on new purchases.
While the opportunity to pay off high interest card balances more quickly is attractive, borrowers need to be aware of the rate trap on balance transfers. If any transferred balance that remains at the end of the promotional period – be it six, 12 or 18 months – your interest rate will increase to the normal range charged by the issuer. Worse, the new rate may be charged retroactively on your entire balance transfer! If you accept a balance transfer offer, make sure you make sufficient monthly payments to pay down the entire balance or it could end up costing you more.
The Right Solution for the Right Reason
There are some pretty sound reasons why a balance transfer should be used. It can lower your interest costs. It can consolidate smaller, high interest balances. It can help you increase your cash flow. And, it is possible, to manage a “long term” balance transfer strategy that could help you pay down debt more quickly and save more money. However, only the most disciplined borrowers should try to use that strategy, as it requires careful tracking of introductory periods, new offers, transfer costs, and, the presumption that more offers will come.
