Credit card debt has one of the highest interest rates in the market. In 2018, households paid an average 25 percent interest on their credit cards. Given that the average consumer owes around $16,000 in credit card debt, according to NerdWallet, such a high rate often means families have to pay hundreds or thousands of dollars in interest alone.
There is a way to avoid paying interest on credit card debt. This process, called a balance transfer, allows people to pay 0 percent interest on their credit card debt for several months or years. However, as credit card debt rises, the number of balance transfer credit cards have decreased. Here’s everything you need to know about balance transfers and how they work.
What Is a Balance Transfer?
A balance transfer is the partial or full transfer of debt between one account to another, often held by a different financial institution. Balance transfers are often offered by banks and credit card companies as a way to attract new customers. The most common way of performing a balance transfer is by applying for a new credit card which includes this feature. Most balance transfer credit cards come with low or no interest charged on transferred debt, albeit only for a specified period.
Customers who perform a balance transfer must pay a fee to the target financial institution. In most cases, this fee can either be a flat number or a percentage of the amount being transferred. However, financial institutions often have a minimum fee for balance transfers below a certain amount. For example, Citi’s Simplicity Card has a balance transfer fee that equals 5 percent of the amount per transfer. However, if customers transfer less than $100, they will pay a $5 flat fee.
The benefits financial institutions make available to customers who perform balance transfers depend on their creditworthiness. For example, Citi’s Simplicity and Double Cash credit cards offer customers 0 percent interest rate on balance transfers for 18 to 21 months. However, balance transfers must be completed within 4 months of account opening. Otherwise, customers must pay between 16 and 26 percent annual interest rate. Bank of America’s BankAmericard also offers 0 percent interest rate for 18 months, but balance transfers must be completed within 60 days instead of 4 months.
Balance transfer credit cards with 0 percent APR for extensive periods are usually available to customers with credit scores above 680. If someone has a credit score between 580 and 679, financial institutions may offer the same benefits but for shorter periods. For example, Aspire, a federal credit union, offers a Platinum Mastercard with 0 percent interest rate on balance transfers for 6 months. After that, customers must pay interest between 8 and 18 percent, according to their credit history.
Balance transfers made to existing debt accounts often have less attractive benefits. Using the credit cards in the above example, a customer would have to pay between 8 and 26 percent annual interest rate on balance transfers made after the specified grace period. However, performing a balance transfer is such a scenario would make sense if the target credit card is part of a rewards program.
Why Transfer Your Balance?
Most people perform a balance transfer to save money they would otherwise pay on interest. For example, an individual has a $3,000 balance on their current credit card, with a 19 percent annual interest rate. To pay off the entire balance in 18 months, they would have to make monthly payments of $192, totalling $3,456. However, if they transfer the balance to a new credit card with 0 percent interest for 18 months, their monthly payments would fall to $167. If the credit card issuer has a 3 percent balance fee, total amount paid would be $90, much lower than the $456 paid in interest. By performing a balance transfer, the individual saved $366.
Another reason why people do balance transfers is to consolidate debt into a single credit card. Aside from helping save money on interest, debt consolidation helps people keep track of less individual bills. It is not uncommon for credit cards to have different due dates. By moving all outstanding balance to a single card, consumers can organize their finances more efficiently and understand how much debt they have.
Financial institutions do not impose limits on how many balance transfers can be performed by consumers. Instead, they limit the period in which customers can transfer and pay no interest rate on incoming balances. This means someone with outstanding debt on three or four credit cards can consolidate all their balance into a single new card and save money on 0 percent interest promotions. Once the 0 interest period is over, consumers can then request another card with a fresh promotion, transfer any remaining balance, and continue enjoying the benefits.
How Balance Transfers Work
Before a balance transfer can be performed, consumers must first compare available offers and choose one that best suits their needs. Then, they must submit an application for the credit card. The application process can be completed online or through a phone call. Most financial institutions ask for contact information, social security number, and annual income. Applications for balance transfer credit cards also request creditor names and account numbers needed to complete the transfers.
Not all banks ask for creditor name and account numbers when customers submit an application. Nowadays, most credit cards come with some form of balance transfer promotion, so customers can submit relevant information later if they desire to take advantage of the service. However, as explained above, customers must keep in mind the period financial institutions give to receive promotional interest rates.
Once an application is approved, the target financial institution will perform a balance transfer according to the credit limit given to customers. For example, a customer requested a balance transfer for $6,000 but the bank only approved a credit limit of $4,500. In this case, the financial institution will perform a balance transfer for $4,500. The difference, $1,500, will remain in the old credit card.
The balance transfer is complete once a financial institution confirms payment has been made. In general, banks inform customers by sending a statement that also includes the new monthly payment amount and due date. Customers should be aware that some financial institutions may still issue one more statement charging residual interest after a balance transfer is complete. This last statement must be paid even if no outstanding balance is left. Otherwise customers may have their credit scores negatively affected.
How To Qualify For a Balance Transfer Credit Card
Credit cards that come with promotional interest rates for balance transfers often have strict requirements. Most financial institutions, like Citi or Bank of America, require credit scores above 680 points before approving a balance transfer credit card. They also often ask for no more than two hard credit inquiries in the last six months. Customers who apply for balance transfers must also not have maxed out their other credit cards.
People with scores between 580 and 680 can still get approved for a balance transfer credit card. However, only small banks and credit unions offer 0 percent interest rate promotions to these customers. If a customer has a score below 580, they will most likely not be approved for a balance transfer credit card. In such cases, it would be a good idea to improve their credit score before applying for one. This is because credit card applications often register a hard inquiry on a person’s credit history.