Wednesday, 29 May 2019

What is a Balance Transfer? How Does It Work

What is a Balance Transfer? How Does It Work

Today I want to write a new article about balance transfers, I'm really going to answer three questions about balance transfers 
  1. What is the Balance Transfer Offer?
  2. Why doing a balance transfer?
  3.  It is a good idea to do a balance transfer?

Let's start with

What is the Balance Transfer Offer?

Let's say I apply for a new credit card, I get approved, I get that credit card in the mail and it says you have a $2,000 credit limit, great, I go out and spend $1,000 on the card buying things and now I have what's known as a $1,000 credit card balance

That also means I owe the credit card company $1,000 or in other words, I'm in a thousand dollars worth of credit card debt

  • A balance transfer is where I can transfer that debt from one card to another card.

2.  Why doing a balance transfer?

The second question is why would I want to do that, why would I want to transfer debt from one card to another card I'm still going to owe somebody that money, well, credit card has what's known as an APR or an interest rate and that basically is how much interest you have to pay the credit card company if you can't pay off all your purchases within a billing cycle

  • If I owe $1,000 on my first card and I can't pay it off before the billing cycle is over now it rolls over into the next month and I get to charge interest on that.

Different credit card has different interest rate and sometimes credit cards have introductory rates, for example, if I apply for another card it might come with an introductory balance transfer offer where I pay 0%, so no interest for the first year and a year half, maybe two years those are some typical time links that you'll see

But basically if I transfer that balance from my first card even though I couldn't pay it off completely, with the new second card, I'm paying no interest for the first year and a half,  now I've saved all that money that I would have spent paying interest to the first credit card that had the 20% APR

That's why you would want to do a balance transfer offer, is to basically save money on the interest, so it might not be 0% that you're transferring to but even if you can transfer it to a lower APR you end up paying less money in the long run in the interest

3. It is a good idea to do a balance transfer?

  • Now, the question is, is it a good idea to do a balance transfer?
  • The answer is no, it's not a good idea to do a balance transfer unless you have a great plan.

You might think of a balance transfer as like oh great this is interesting, free for a year and a half, I can transfer that balance and then I can forget about it for a year or a year and a half and then I can pay it off

But you're really not doing yourself a favor by doing that because you're just going to have to pay it off anyway and now you are going to have the balance transfer to fall back on potentially, you may have deferred the interest for year or year and a half and maybe your financial situation will improve,

That's probably not the smartest thing to Bank on and instead it makes sense to have a solid plan in place to either cut back on your spending or otherwise take a look at how you ended up in that position where you couldn't pay off your credit card balances in full and correct that problem first

Then if it makes sense and you have a plan to where you'll be at zero dollars of credit card debt then it might make sense to open a balance transfer credit card, transfer that balance and then pay it down before the 0% period runs out.

The Fee on the Balance Transfer 

Another important thing to consider is the fee on the balance transfer 

Let go back to the example where I have $1,000 of credit card debt on my first card and then I have a let's say a one-year 0% period on the second card 

I want to transfer that $1,000 of credit card debt and even though I don't have to pay any interest on it for the first year, the second card with the balance transfer offer might charge me a percentage of that balance over for that privilege of being able to transfer the balance

  • Typically you'll see a fee of like 5% for this, so if I'm transferring a $1,000 balance, I'm paying the credit card company an extra $50 fee to be able to take advantage of that 0% offer 

When you're talking about a couple thousand dollars of debt that can really start to add up, but it can end up being a lot less than you might have paid interest on the card that you're transferring the balance from.

That's an important thing to keep in mind and also it's really important to read the terms of any card that offers a 0% intro period or some kind of 0% intro balance transfer period because sometimes there will be a stipulation that says if you transfer within the first 60 days you don't have to pay a balance transfer fee

There are other cards that if you transfer a balance and you don't pay your entire balance off by the time the balance transfer or the 0% period is over, you will actually have to pay interest all the way back to when you opened the card, so that situation can be terrible if you're really in debt and trying to get out of debt.

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