Managing Your Debt with Balance Transfers: 6 Hidden Dangers You Need To Know
Balance transfers are a useful financial tool when you’ve gotten yourself in a bit of a pickle with credit card debt. The average American household has $7,123 in credit card debt. So it stands to reason that a lot of people are searching for services and tools they can use to manage their debt better. If you belong to that category, you’ve probably already looked at using a balance transfer to lower the amount of interest you incur on your debt.
The service works to eliminate your debt at a much faster rate by transferring it from a high interest credit card to one with zero or very low interest rates. When you aren’t being charged interest for a period of time your payments go further towards reducing the debt.
Before you get too excited about eliminating your debt in record time and open a credit card that offers a zero percent introductory interest rate on balance transfers, I want to warn you of a few hazards that can befall you if you use this service. Don’t get me wrong, the service is great, but only if you use it aggressively and in the right way; which is hard for many people to do when it comes to money.
Let’s go over the six hidden dangers of balance transfers so you don’t get caught up and put yourself in a worse financial position with more debt than you started with.
1. New Purchases Don’t Receive the Same Low Rates
Let’s say you have a card balance of $3,000 that you transfer to a new card that offers you a zero-percentage interest rate on balance transfers for the first year. Since the card has a little more room you also use it to pay some bills that you’ve been putting off totaling $1,000.
You get your first bill and see the minimum payment required is $120. You want to pay off your debt fast so you send them $200. The problem with this strategy though is that your credit card company considers you to have 2 separate balances, while you presume you only have one. The credit card company in turn chooses to split your $200 in payments up between the 2 balances in order to make the most amount of profit off of you.
What split works best for them? They’ll take $120 –the minimum payment amount—and apply that to the zero percent interest balance. That way they apply what’s left –$80—to the higher rate balance. This keeps the balance that’s actually earning them money on the account longer.
Needless to say, if you typically only pay the minimum monthly payment on your cards, that entire payment will go towards paying off the balance that’s costing you nothing, instead of the balance that’s earning high interest rates and fees.
The right way to use the balance transfer is to not make any additional purchases. Be aware that only the amount you transfer is eligible for the zero percent interest rate. Every purchase you put on there in addition to that has a separate and much higher earning interest rate. The card with a zero percent introductory rate for balance transfers should be used exclusively to pay off your debt, the minute you use it for additional purchases you mess up your valiant efforts.
2. Your Zero Percent Rate Doesn’t Last Forever
The card issuer calls the balance transfer rate introductory for a reason, once the time period is up whatever balance you have on the car is subject to the regular interest rate, which is often higher than other cards.
Even though these terms are clearly spelled out for the user research shows that 34% of people who use balance transfers don’t pay off their balances within the introductory period. As if that weren’t bad enough, another 20% of users fail to follow the rules during the introductory period which results in reverting their zero percent interest rate to a much higher rate. That means that over 50% of the people who use this tool to pay off their debt don’t get the chance to. In reality, they find themselves in a much worse position –their debt is now on a credit card with above average interest rates.
Balance transfers to cards with zero percent interest rates for a period of time are very useful, but only if you read the terms carefully and don’t violate them, and you create a detailed plan on how to pay off your debt before the card reverts back to charging higher interest rates.
3. Fees Often Erase Much of Your Savings
No matter what you read or what the credit card companies promise you, cards that offer zero percent interest for balance transfers do not offer this for free. It used to be that card companies charged consumers 1-3% of the transferred amount. So for a balance transfer of $5,000 a card company would add up to $150 in fees to the balance. Now a days these fees are generally 3-5% of the transferred amount, which raises the charges up to $250. That’s a lot of extra cash to pay off, especially when you only have months to pay off your debt.
Before you transfer your debt to card advertising a zero percent interest rate, calculate just how much these fees will eat into the savings you get. If your debt is small enough, balance transfer fess could eat up any savings you hope to reap.
4. Professional Cards are Anything But
Once Congress enacted the CARD Act in 2009 to help protect consumers from unscrupulous practices, credit card companies had to find new ways to make money off of us. Enter “professional” credit cards. Once only offered to small businesses, card companies are now allowing anyone to sign up for these cards. Why? Because they are not covered under the CARD Act. Credit card companies can change your terms without notice, raise your interest rate, levy higher late fees, introduce new fees, revoke your introductory period…all without you being able to do anything about it and without breaking any laws.
Beware of signing up for a “professional” credit card. No matter how great a card company makes them seem, they have the power to damage credit scores and push consumers struggling to pay off debt into worse financial positions.
5. Rewards Programs on These Cards are a Scam
Credit cards that offer a zero percent introductory rate when you transfer a balance to them don’t make any money off of you if you follow the rules exactly. That’s not good for these companies. In order for them to make money off of you they’ve got to get you to make new purchases. If you look back to unscrupulous trick number 1, you’ll remember that new purchases don’t receive a zero percent interest rate; they are charged at a much higher interest rate. In order to get you to make new purchases these companies offer incredible rewards programs. They offer cash back or points or other bonuses that seem to good to be true. And most of the time they are.
If you transfer your debt to a card that offers a zero percent interest rate for a limited time, don’t use that same card to make new purchases. Remember that rewards programs are simply marketing tools used by credit card companies to encourage you to spend more money and run up more debt. It’s important to use this card solely as a financial tool to pay off your debt faster and not for anything else.
6. They Hurt Your Credit Score
It’s not these cards specifically that will drop your credit score, but how you go about transferring a balance that can. To transfer your debt to a zero percent interest card you’ve got to open a new account. Any time a company does a credit inquiry –which all new credit card applications require—your credit card drops a few points. Adding to the damage is the fact that your new account lowers the average age of your credit profile. If you cancel your old card after transferring your balance, you will probably tip the balance negatively on your debt-to-credit ratio, which compares how much you owe to the amount of credit available to you. All of these actions lower your overall credit score, which can cause you to pay more in other areas of your life.
Balance transfers are a useful tool that can help you manage your finances if used appropriately and if attention is paid to the fine print. While they can help you pay off your debt, the only way to truly become financially free is to never get into credit card debt ever again. Only you can make the behavior changes necessary, no matter how many letters from me you read.
Keeping Money in Your Pocket,