What is a balance transfer?
A balance transfer is the process of moving your debt from one credit card to another credit card, usually to one with a lower interest rate or in some cases; an interest free rate for a certain period of time.
Pros of balance transfers
Allows you to consolidate debt
A balance transfer allows you to combine multiple credit card balances onto one card. This means rather than paying interest on several credit cards at different rates, all of your debt will be on one card which should make it easier for you to manage your payments as you will only have one interest rate and due date to manage.
Lower/no interest payments
Many balance transfers offer the incentive of 0% interest for a certain period of time. Interest rates on credit card balances can often be very high and often keep many credit card users in debt. A reprieve from paying interest should allow you to reduce/pay off your debt more easily and quickly.
(According to Moneyfacts the average interest free-borrowing period on the top 12 best-buy cards is just 23 months, down from 28 months a year ago. The data company also found that the longest free borrowing periods available to consumers today are just 29 months, down from 36 months last August.)
Improve your credit rating
If your new balance transfer credit card has a higher limit than your previous credit card; your credit utilisation rate should decrease. (Assuming you don’t incur any more debt than you already had)
For example; if your old credit card had a credit limit of £2,000 per month, and you used up £1,000 per month, this means you would have been using 50% of your available credit. (known as credit utilisation)
If you transfer your £1,000 debt to a new credit card with a £5,000 limit, you’ll only be using 20% of your available credit. The smaller this percentage is, the better it is for your credit rating. To boost your score, pay down your balances, and keep your credit utilisation low.
Cons of balance transfers
You have to pay an initial fee
Most credit card companies will ask for an initial fee, whilst this may be small in comparison to your balances. It is worth shopping around to get the best deal.
NB. Research has found that as interest-free periods have shortened, fees for borrowing have increased. The average fee across the top dozen balance transfer cards today is £75.43 for £3,000 of borrowing.
Promotional rates only last so long
You should remember that any promotional rate you are given will only last for a set amount of time. You should consider if you will be able to repay your balance during the time you have the promotional rate. Don’t forget that once the promotional rate has finished you will go back to paying interest on your balance if you have not already paid it off.
Whilst there is potential for you to carry out a balance transfer to a credit card with a larger credit limit; there is also a risk that your new card may have a lower credit limit than your initial credit card.
The amount of credit you are given is based on a number of factors and can vary from lender to lender. Be prepared to only be able to transfer a portion of your debt to your new card.
Risk of Accumulating More Debt
Some consumers may be tempted to continue to spend and add more debt because of:
- The interest free period offered by carrying out a balance transfer
- An increased credit limit
This can result in you ending up with more debt than you started with. It is important that you are disciplined and careful to not fall into the trap of increasing your spending to match your new higher limit.
Tip: Cut up and close your old credit card. This will remove any temptation to rack up more debt.
Short term impact on your credit rating
A balance transfer can impact your credit score short term. Each time you apply for a financial product, a search will be recorded on your credit record (the so-called credit footprint). If you apply for lots of credit or are declined credit many times in a short period of time this will impact your credit rating.
Making a final decision
There are both pros and cons to carrying out a balance transfer. Overall, a balance transfer used properly can provide you with a great way to help you stay on top of your repayments; however; if you’re not careful or aware of the potential drawbacks, you could wind up with even more debt. Ensure you consider the pros and cons before deciding if a balance transfer is a good option for you.
*This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published.