What You Need To Know Before You Do A Balance Transfer
One of the common ways to manage multiple credit cards and pay off debt quickly is by transferring your credit card balances from one or multiple credit cards to a single card that offers a much lower interest rate usually for a fixed period of time - Typically, you'll find balance transfer offers advertised at a 0% introductory interest rate.
While this approach might work if you are trying to save money on interest while you pay off your debt, it is also a huge trap people fall into and this is because credit card companies offer balance transfers and it's associated incentives, as a way to make money.
"Playing around balance transfers can be a very expensive game if you don't have a proper strategy in place."
How do credit card companies make money on balance transfers?
Well, it's a pretty known fact that most people do not pay off the balances they transfer before their introductory rate expires which in turn allows the credit card companies to charge more interest than normal based on the agreement you made with them.
This is because the interest rate on your balances after the introductory period is over, can be much higher than usual (details of which are highlighted in the fine print that can be pretty easy to glaze over).
The psychology of balance transfers - Why people don't pay off their balances
People don't pay off these balance transfer amounts because they get comfortable seeing the "new" lower interest rate and they think they have now have more time to pay.
In addition, many people end up increasing their balances through new spending because they think that now that they've reduced their interest, the debt will be much easier to pay off.
Tips to create a proper balance transfer strategy
When it comes to balance transfers you should only do it if you have a solid sense of the following key points:
1. You know for sure you will be paying off the entire balance transfer amount within the introductory offer period
In other words, you need to make sure you can afford to pay off your balance in full before the introductory period expires. Have you calculated how much you'd need to pay each month to pay off your balance in full by the expiration date? Here's a calculator to help you out.
2. Be aware of the balance transfer fees and make sure they make sense
Many balance transfer agreements require you pay a percentage of your balance as a processing fee e.g. 2% - 10%. So it's important to ask yourself when you do your calculations, if this 2% - 10% fee is worthwhile (will you still save money?) when you compare your current interest rate vs. the fee amount broken up over the introductory period, assuming you plan to pay your balance in full within that time.
If you run your calculations and find that you can't pay your balance off in full before the introduction period offers, it might actually cost you more money in the long term if you make that balance transfer.
Tip: If you choose to do a balance transfer, look for a card that has no fees for the transfer and has a 0% introductory period of at least 12 months (in which time you can work to pay off your balance).
3. Consider focusing of paying off your balance in full where it is now
Again, the credit card companies are not doing you any favors, offering balance transfers is a strategy they use to make the maximum amount of money possible on interest and for the most part - they always win. So don't get into this game without a plan of attack.
If you feel like doing a balance transfer is going to be more trouble than it's worth, don't do it. The short term gratification of a 0% interest rate that is inevitably going to lead to you paying more interest over time is not worth it if you won't be paying off your balance in full before that 0% interest rate is gone.
The surest way to win, is to buckle down and pay off your debt as aggressively and as quickly as possible.
Tip: If you choose to do a balance transfer, don't run up new debt on your old credit card or on the new credit card. Remember the whole point of doing the balance transfer is to save money on interest payments so you can pay your balance off faster. Also, be sure that you don't miss any payments or pay late as this could void your 0% interest rate.
Have you successfully used balance transfers to save money on interest while you paid off your debt or was doing a balance transfer more trouble than it was worth? Share in the comments!