The average U.S. household has a credit card debt of $6,006. These figures may seem high or low depending on who you ask. However, if you’re someone who is having trouble making repayments, credit card interest can quickly become overwhelming.
Credit card debt is often considered as a bad debt because it diminishes your wealth over time. Although, in the context of a balance transfer, this type of credit card can be an effective way to reduce your repayments. In this article, we’re going to explore what a balance transfer is, how it works, and the fine print you should always consider. This may help you compare and make an informed decision.
Let’s start off with the basics by first defining what a balance transfer is.
A balance transfer is when you move one debt into another debt. For example, let’s say you have a Mastercard, American Express and Visa credit card–all from different banks. Your Mastercard has $2,000 owing, your American Express has $3,500 owing, and your Visa credit card has $3,000 owing.
Doing a simple calculation, you owe a total of $9,500. But this is not the complete story.
This is because each credit card has its own interest rate (also called annual percentage rate - APR) and these can typically vary from 12% to 24%.
For the sake of this demonstration, we are going to make the following assumptions:
Using a credit card repayment calculator, it will take you 3 years (36 payments of $300) to be completely debt-free. That is, paying $10,668 in total where $1,168 is going towards the interest.
This is where the concept of a balance transfer can help you save money paid towards credit card interest.
A balance transfer is the process of consolidating these debts into one single repayment plan. Using the previous example, instead of paying three different interest rates, a balance transfer will combine them under one single annual percentage rate where the interest rate is lower than those from your existing Visa, American Express, and Mastercard credit cards.
The goal of a balance transfer is to reduce the amount of interest paid by as much as possible. That is, instead of paying $1,168 in interest, a balance transfer credit card could reduce this significantly provided that you make the monthly repayments during the promotion period.
A balance transfer credit card is a credit card that allows you to transfer an amount of money (often up to 80% of the card’s credit limit) from one credit card to another.
In terms of benefits, a balance transfer primarily has two:
Paying interest does not add to your personal wealth. It does the exact opposite and this is why credit card debt is seen as a bad debt. The whole point of a balance transfer is to allow you to repay the principal amount while reducing the amount paid towards the interest.
By doing this, you can also improve your credit rating.
“A credit score, also known as a credit rating, is the number that represents your financial history. Banks and other lenders use this score to indicate your reputation as a borrower, determining your creditworthiness to pay them back” - Clearscore.
While your credit score may not seem important to you right now, ignoring it can prevent you from gaining access to favorable loan terms in the future. There are many free ways to access your credit score–Credit.com is one way.
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As with any financial product, read the fine print and seek professional advice. When it comes to balance transfers, if you don’t pay off the balance you transfer within the stated time, it may end up costing you more. And that’s the exact opposite of what you’re trying to achieve. Similarly, if you start making purchases with the balance transfer credit card, you’ll have to pay these off first and with many cards, the APR can exceed 20% p.a.
In closing, here are a few things to look out for when shopping around for a balance transfer credit card:
Learn more: Credit Cards with No Annual Fees