How Do Balance Transfers Work?

A balance transfer is when you repay one form of debt or credit with a new credit card. When the debt is transferred it does not actually pay the debt off. Instead, it just shifts where the debt is located from one place to another. This is done in order to get a lower interest rate on the debt, helping you to pay it off faster with less added cost.  

A balance transfer can be a great way to solve your debt problem if you find yourself stuck in a high-interest loan. Many credit card companies, including Discover and Capital One, offer rates as low as 0% APR, but it’s important to remember that a deal that sweet doesn’t just last forever. Typically a balance transfer credit card will eventually start charging interest rates after a set amount of time, that’s why it’s very important to talk to your lender about the terms attached to a balance transfer credit card before proceeding. You don’t want to find yourself back in the exact same cycle of high-interest debt that you were trying to get out of.

It’s also important to point out that it can be pretty hard to be approved for a balance transfer credit card with a 0% interest rate if you don’t have a great credit score. If your credit score is poor and you’re still approved, you should look long and hard at the terms and rates to make sure it’s not going to end up as a trap.  

So How Does it Work?

When you are approved for a balance transfer, the credit card company pays off the debt of the loan from your previous lender. This closes out your original loan agreement and you are no longer on the hook for the loan you originally took out. Your payment obligation is then shifted to your new credit card at the new rates that you have agreed to. It is also noteworthy that in many cases you can action a balance transfer on a multiple-use credit card, meaning if you’ve taken out a new credit card with better interest rates than that of your previous loan, it’s possible to transfer your debt to this card, while still using it for other purposes.  

Once you transfer your debt to the new card, you are responsible for paying off at least the minimum required amount every month, which will be listed on your monthly bill. It’s important that you pay at least the minimum on time to ensure you stay in good standing and are allowed to maintain a 0% interest rate on the card. However, it is highly recommended that you pay off more than the minimum on the card, and try to pay off the entire sum of your debt within a few months to a year. Although most balance transfer credit cards have intro rates of 0% APR,  those rates tend to jump up quite a bit after the intro term is over. So if you don’t pay off your debt while the rates are favorable you may find yourself back at square one with high-interest payments on a loan you can’t seem to shake.

Prioritizing Debt

If you have multiple debts to consolidate, and aren’t sure you can take care of them all before the favorable terms of a balance transfer card expire, it’s a great idea to take a look at your outstanding debt and prioritize the highest interest rates first. If you can cancel out two loans with high-interest rates by paying them off with a balance transfer, then surely it will be easier to take care of the rest of your outstanding loan payments with more favorable terms. It’s also possible to apply for another balance transfer card, but it’s worth noting that the more lines of credit you take out in a short period of time, the lower your credit score will be. This is based on a metric that credit reporters call credit inquiries. However, after two years your credit inquiries are wiped, and no longer impact your credit score.

The Risks of a Balance Transfer

Using a 0% APR card to wipe your loans off the map sounds like a great deal, but it’s important to point out that the deal isn’t always so sweet. Typically, lenders charge a balance transfer fee when you transfer your debt to a new card. The average transfer fee is 2.62% of the amount you transfer, but some cards can charge as much as 5%. This fee is charged to pay for processing the transaction, as well as offsetting the risk of assuming your debt. It’s not impossible to find a balance transfer card that doesn’t charge a transfer fee, in fact, there are quite a few credit cards that don’t charge a fee at all, however, these cards tend to not offer a 0% APR. Still, the intro rates on these cards are generally quite favourable, and surely better than the interest rates you are currently paying if you’re looking for a balance transfer, so if you’re looking for a balance transfer and can’t afford an upfront fee, looking for a balance transfer card with no fee and a low but not 0% APR is definitely worth it.

If lowering the interest rate on your debt isn’t convincing enough, credit card companies have a couple of ways they sweeten the deal, the biggest being rewards. Depending on the lender, a balance transfer credit card can be a great opportunity to earn rewards and points of all sorts. You could earn air miles, money back, and all sorts of bonuses that make a large debt transfer to the new card a sweet deal. Not all balance transfer credit cards are eligible for rewards, which is understandable. If you’re transferring a huge amount of money onto the card right away, that’s a lot of reward points. But lenders like Barclays and others do offer reward points on balance transfer cards. Make sure to look at the fine print of your balance transfer credit card before signing to see if you’re eligible for reward points and get the best deal you can.

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