Dave Ramsey and other popular financial pundits are fond of saying things like “You can’t borrow your way out of debt!”
The advice is to those that would like to open up a new credit card for a balance transfer, or get a new home equity loan or home equity line of credit in order to pay off their current debts.
And generally speaking, borrowing money to pay off borrowed money is a losing game.
Their advice is for those that can’t handle the financial responsibility of paying off the debt and spending less than they earn at the same time.
If you continually spend more than you earn, no amount of balance transfers or new lines of credit will save you.
Since many people calling into the financial shows can’t handle that responsibility (they are up to their eyeballs in debt currently, right?) the advice points against this strategy.
However, that doesn’t mean transferring a balance from one credit card to a new one is always a bad idea.
If you are smart about how you handle the balance transfer it can actually save you thousands of dollars in interest and result in you being debt-free a lot earlier than you would have been otherwise.
How Does a Balance Transfer Credit Card Work?
Credit card companies love to spam the public with paper marketing offers. We’ve all received an envelope marked “0% for 18 months including balance transfers!” at some point in the past.
With these types of offers the idea is to move one lump sum of debt from a high interest rate creditor (like a credit card with a late payment) to another creditor at a lower rate (usually another credit card company).
For example, let’s say you have a credit card with a $10,000 balance at 17% with Credit Card Company A. You get an offer in the mail from Credit Card Company B for “0% APR on balance transfers for 12 months” and quickly decide that 0% is a lot less than 17%.
You call in, complete the application, and are granted a $10,000 line of credit. Your new credit card company (Company B) sends your old credit card company (Company A) a check for the $10,000 balance and you now owe the new credit card company (Company B) the money instead.
When Does a Balance Transfer Make Financial Sense?
Moving money from one creditor to the next does you no good if you can never pay off the balance.
A balance transfer only makes sense if:
- you can be approved for the new line of credit needed to complete the transfer
- you can afford to pay off the debt during the balance transfer offer (or at least make significant progress against it)
- you won’t rack up new debt on the credit card you just transferred the balance off of
If you can’t handle these three things, a balance transfer isn’t for you.
A balance transfer that you can just barely afford does help, but you won’t make any significant progress on your debt and will have to hope you can get yet another balance transfer in the future. If you don’t stop overspending on your other lines of credit you will just end up with two big balances to pay off rather than one.
4 Factors to Consider When Looking at a Balance Transfer
Here are four significant factors you need to look at before taking on a balance transfer offer.
1. What is the rate?
The first factor to know is what the new interest rate will be on the balance transferred to the new credit card.
Most offers are for 0% for a certain period of time, but there are some banks and credit unions that offer flat rate at 4% to 9% based on your credit history.
The rate you receive is one of the largest factors in your decision to do a balance transfer. If you can drop a 17% debt down to 0% or 4% you are going to save a ton of money on interest payments.
2. What will the new payment be?
This is key in determining how much of a dent you will be able to make in the debt.
For example, if your $10,000 debt at 17% is constantly making you spend $300 more than you earn — you’re going deeper into debt — and the balance transfer drops your payment $305 per month you really aren’t improving your situation all that much. Yes, you aren’t going further into debt. But when the balance transfer offer runs out you will either need to find a new balance transfer or be stuck paying the high rate of the new company.
That kind of balance transfer helps you stop taking on water, but you’re still stranded at sea. You’ll need to find other ways to cut back, earn more income, or both in order to work on actually paying off the debt.
The best situation is where you have a little extra money left over each month and a balance transfer (with a significant interest rate reduction) gives you enough breathing room to actually pay the debt off during the balance transfer period. (Or if not completely paid off, a huge portion of it wiped out by your extra payments.)
3. What is the length of the offer?
Some balance transfers promo rates are for 12 months. Others 15 months. And yet others 18 months.
The length of the offer significantly changes how much of an impact you can make on the balance. If you knew you could choose between 12 months at 0% and 18 months at 0%, you would choose 18 months every single time.
Yet sometimes the offer that is mailed to you is just for 12 months. Keep searching or call in and ask for a longer term. Those 3 or 6 extra months might result in you completely paying the debt instead of just paying off a portion of it.
4. What are the balance transfer fees?
This is the unfortunate part where you learn that performing a balance transfer will cost you money 99.9% of the time. Most major companies now charge a balance transfer fee of $10 (or some other nominal amount) or 3% of the balance that you transfer over, whichever is higher.
That means transferring that $10,000 balance at 17% to a new offer for 0% for 12 months is really costing you 3% instead of 0%. You’ll pay the $300 in balance transfer fees just to get started.
However, even with that kind of fee in place if you can drop 10%, 14%, or 20% off of your rate you are still coming out ahead as long as you actually pay the balance off.
You can make great strides in tackling your debt using a balance transfer credit card. But you are only helping yourself if you don’t dig yourself deeper into debt and you actually take that low- or zero-percent interest period and pay more towards your credit card balance.
If you are looking for a balance transfer credit card here are some offers that have 0% introductory APR.