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How Does a Balance Transfer Work?

Posted By Jim On 05/21/2012 @ 7:20 am In Credit | 6 Comments

A balance transfer is when you transfer your balance from one credit card to another, presumably to take advantage of lower rates. Some credit cards will write you a check for the amount, rather than having you jump through the hoops of paying another credit card company.

Why do credit cards offer balance transfers? Credit cards are in a constant battle to get a “share of your wallet [3].” They want to get into your wallet so that you’ll be more likely to use them when you make purchases, so all the cash back offers and reward programs exist to gain a piece of that share. They earn a percentage off each transaction, so having a large share is crucial to their business.

They have balance transfer offers [4] because they know the longer you have the card, the more likely you are to use it. If you have a balance on your card, they’re playing the odds and thinking that you probably won’t be paying off that balance for a few months. Those are precious months they can sit in your wallet.

Why Balance Transfers Help

The appeal of a balance transfer is that you are essentially getting interest free money. Many balance transfers are 0% for twelve months, which gives you an additional year to pay back that debt. Balance transfers can help you get out of debt if you use them responsibly, but they can also enable your bad habits, at least for another year.

My favorite story about how a balance transfer helped reader involves those 0% financing deals you see in furniture stores. One tricky thing about 0% financing [5] when it comes to furniture (and many other products) is that if you don’t pay off the loan before the 0% financing ends, they will charge you interest on the balance for the entire period. So if you had a 12 month 0% financing offer for a couch and you still had a balance after the 12th month, they immediately tack on 12 months of interest. It’s shady. So a reader used a balance transfer to get herself a few more months to pay off the couch (she had 12, she only really needed one or two).

What to Watch Out For

Purchases accrue interest at regular rates. When you initiate a balance transfer, the amount you transfer onto your card will enjoy the favorable 0% interest rate for the promotional period. If you make any additional purchases with that card, those purchases will accrue interest at whatever the regular rate is, which can be in the double digits. All of your payments to the card will apply to the 0% balance, not the “other” balance being charged regular interest rates.

After the promotional period, your interest rate goes up. It’s important to look at the card’s regular interest rate because the moment your promotional period ends, that’s the interest rate you will be charged. If you want to transfer a balance, compare your current interest rate against the regular interest rate of the new card to see if it makes sense. If you can pay off your balance within the promotional period, then this is less of a concern.

Review balance transfer fees. The days when you could transfer a credit card balance for free are long gone, credit cards now charge an up front fee on the balance amount that ranges anywhere from 3-5%, with a minimum dollar amount. Run the numbers to see if the transfer makes sense and can help you get out of debt faster.

I long for the good ole days when you could get 5% interest from a high yield savings account [6] and we played the balance transfer arbitrage game – get a balance transfer, put it into a savings account, collect interest, and then pay back the transfer. Those were fun ways to make a few bucks, at the cost of a few points on your credit score, and perfectly safe.

(Photo: andresrueda [7])


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[1] Tweet: http://twitter.com/share

[2] Email: mailto:?subject=http://www.bargaineering.com/articles/balance-transfer-work.html

[3] share of your wallet: http://www.bschool.nus.edu.sg/Departments/Marketing/Jochen%20papers/wirtzmattilalwinjsr2007.pdf

[4] balance transfer offers: http://www.bargaineering.com/articles/list-of-cards-with-0-balance-transfer-offers-for-12-months.html

[5] tricky thing about 0% financing: http://www.bargaineering.com/articles/beware-0-interest-finance-offers.html

[6] high yield savings account: http://www.bargaineering.com/articles/high-yield-savings-accounts-rates.html

[7] andresrueda: http://www.flickr.com/photos/andresrueda/3274955487/sizes/m/

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