Find yourself with a large set of credit card balances that you never seem to be able to put a dent into? You can pay your minimum payment, but that’s about it. At the rate you are currently paying off the balance you’ll spend the next four decades paying off the balance. You are frustrated, sad, and lost.
One day you check your mail, and there’s a credit card offer inside. Normally you immediately shred the document and move on with your life, but this one has the words “balance transfer” in bold, bright colors on the front.
Is this a good idea?, you quietly ask yourself.
The answer is… maybe.
Should I Use a Balance Transfer to Pay Off Debt?
The risks are high, but the benefits are as well. Here are some things to consider when you are looking att whether or not to use a balance transfer to get out of credit card debt.
Risks of Using a Balance Transfer to Pay Off Credit Card Debt
If performed correctly, using a balance transfer to save yourself from credit card debt can be a fantastic financial move.
It can also blow up in your face horrifically. You are playing a high stakes game when you start moving balances around with balance transfers.
There are two significant risks you must be aware of before trying this.
1. The Risk of Missing a Payment and Getting High Interest Rates
When you take a new balance transfer offer you a normally getting something like 0% for 12 or 18 months, plus a balance transfer fee of about 3% or so. This effectively wipes out the high interest charges you were facing and lets you pound away at the balance to pay it off.
That is until you miss a payment or have a late payment. Then your interest rate gets jacked up to astronomical levels and sometimes is retroactively applied to the whole balance. In short you will find yourself right back where you started: a huge balance at a high interest rate that you can’t afford.
2. The Risk of Getting Back Into Debt on the Original Credit Cards
The other risk involves what happens to the credit card account that you transferred the balance away from. You were likely paying anywhere from 12% to 20% in interest on the card. That’s why you needed a 0% balance transfer offer to save you from the interest payments.
Even if you maintain discipline is paying the balance on the new balance transfer account (to avoid the problem described above), you can still run into trouble if you continue to use your old credit card.
Remember, your irresponsible credit card use got you into this mess in the first place. If you keep the account open (which, in some cases you should because the length of your credit history impacts your credit score), you risk using the same card and getting back into debt. If that happens you now have doubled your problem: you have your original balance transferred onto a new card that you are trying to pay off, and your old card has a new balance on it. You’re doubly in debt and at significant risk of bankruptcy if you cannot pay the balances.
Benefits of Using a Balance Transfer to Pay Off Credit Card Debt
While the risks are high in the balance transfer game, the benefits can be significant. You can literally take your balance at 15%, 18%, or 20% and drop it down to 3% or less. (Even if you have a 0% balance transfer offer there is usually a 3% fee to do the transfer, which means you’ve essentially paid a 3% interest rate on the funds.)
That drastic drop in the interest rate gives you the opportunity to blow your debt out of the water. Where your previous monthly payments were mostly interest and a little bit of principal, you have now flipped the tables. A majority of every payment you send in is going toward principal rather than interest.
For example, let’s say you had a $10,000 balance at 18% on a credit card. Your minimum payment is 4% of the balance, so it starts at $400. If you just paid the minimum it would take you 12 years and 3 months to pay off the debt and you would pay $5,463 in interest on the balance. (Even if you kept the same $400 fixed payment each month it would still take you 2 years and 7 months to pay off the balance. You would pay $2,390 in interest.)
If you were able to transfer the full balance to another card at 0% for 18 months (plus a 3% transfer fee of $300) while keeping your $400 payment the entire time, you would be debt-free in 2 years and 2 months. Your total interest would drop to just $313. Even when you add the $300 balance transfer fee in you have saved yourself $4,850 over paying just the minimum payment. Even compared to the second plan of keeping the flat $400 payments, you have still saved $1,774 simply because the interest rate has dropped so much.
Three Tips to Ensure Success When Paying Off Debt with a Balance Transfer
Here are three things you need to do to be successful in using a balance transfer to get out of credit card debt.
1. Set up automatic payment on the balance transfer account
You absolutely must set up automatic payment of the balance transfer account. You cannot risk having your interest rate jacked up because you are late on a payment. Make sure you set it up to be paid well in advance of the due date so if something goes wrong you have time to react.
2. Stop using the credit cards you are transferring balances off of
You cannot risk getting back into debt on the original credit cards you are transferring the balances off of. You don’t necessarily need to cancel the accounts because that may damage your credit score, but stop using the cards. Many people freeze the cards in a block of ice and keep it in their freezer.
3. Don’t use the balance transfer credit card for any spending
The balance transfer offer is really a credit card. The company will send you a new card in the mail. This doesn’t mean you need to go out and use it. It is much wiser to immediately cut up the card, shred it securely, or put it in the freezer with the other credit card.