What is a balance transfer (and how does it work)
There’s no doubt that credit cards can be a great financial tool and help you build your credit, earn rewards, and access valuable perks. But there’s no escaping the fact that, when you don’t pay off your balance in full, you’re effectively borrowing money from your credit card. And, as we all know, when you borrow money, interest enters the equation.
It’s very easy for interest to balloon as it accrues and starts to compound. Next thing you know you owe a massive credit card debt that just won’t stop growing.
Luckily, there is a potent tool called a balance transfer that can help stop credit card debt from getting out of control. A balance transfer is a smart way to cut down (and sometimes even eliminate) interest for a limited time and therefore speed up your journey to financial freedom. But, as with any tool, you need to know how to use it properly and balance transfers can be tricky.
Here’s everything you need to know about balance transfers.
What’s a balance transfer?
Essentially a balance transfer is exactly what it sounds like. You transfer your balance (aka debt) from one creditor (usually a credit card) to another that offers a lower interest rate. The idea being, that when you move a high interest debt to a lower interest alternative your debt stops growing as quickly. Your debt, therefore, becomes more manageable and easier to pay off.
What’s a balance transfer credit card?
Balance transfers cards are unique in that they offer ultra-low interest rates in the single digits. Sometimes there are even credit cards that feature even lower rates.
Balance transfer deals are available only for a limited time after which the balance transfer offer will end and interest will increase back to the card’s standard level. Normally you will also have to pay a small fee (typically a set percentage of the balance you transfer) to transfer a balance from another credit card. Furthermore, balance transfer promos are usually only available to new cardholders.
What you need to know about balance transfers
Past not present
Balance transfer promotions are a powerful tool for addressing past debts you accrued on older credit cards, but it isn’t a tool for saving on interest for new and future debt you might start to accumulate with the card. That’s because the rock-bottom promotional rates only apply to balances you transferred and don’t apply to any new purchases you charge to the card. Therefore, the best strategy is to avoid using your balance transfer card for new purchases and focus on paying down as much of the debt you transferred as possible. It’s also worth noting that the interest-free grace period will no longer apply to any recent purchases you may make.
Nothing lasts forever
Be warned: after the promotional rate ends, the card’s standard interest rate will kick in. So, if you only managed to pay off half your transferred debt during the promotional period, your remaining transferred balance would start to accrue interest at the card’s standard rate. That’s why it’s vital to pay down as much transferred debt as possible before the promo period expires.
Balance transfer fees
Usually, there’s a fee to transfer a balance. Generally, the fee will be a flat rate that’s a percentage of your transferred balance. So, while you won’t accrue interest there’s still a fee you’ll need to be aware of. This fee may be well worth the price of admission to access a super low interest rate.
Transfer limits
There may be rules that determine how much of your debt you can transfer onto another card.
Credit card providers
You can only transfer debts on credit cards that are from different banks.
Credit check
You will need to apply for a new credit card to leverage the best offers. Just be aware that applying for a new card could involve a hard credit check, which could temporarily negatively affect your credit score.
How does a balance transfer work?
Step 1: Apply for card
Since balance transfer promos are usually only available to new customers, you will need to apply for a new credit card to get a good balance transfer promo. Be sure to compare a few offers and apply for the one that best suits your needs and has a long promo period and low or no interest rate. Also, keep in mind that the card may have income requirements for applicants so don’t waste time applying for cards you are not eligible for.
Step 2: Initiate balance transfer
Some credit cards let you initiate a balance transfer immediately online when applying for the card.
Step 3: Wait for the transfer to go through
It could take a few days or a couple of weeks for the transfer to complete so be patient.
Step 4: Prioritize paying down the balance aggressively
Remember, the balance transfer is only available for a limited time so pay off as much as possible. Also, avoid charging new purchases to the card as those will be subject to the card’s standard interest rate.
Tips for balance transfers
Here are some tips to keep in mind when taking advantage of a balance transfer offer:
- Have a plan and create a budget to ensure you’re paying off as much of the debt as possible during the promotional period.
- Stay on top of bills and due dates. Missing payments could mean losing the balance transfer offer. For example if you miss paying the minimum balance by the due date two months in a row during the promotional period, you will lose the promotional interest rate.
- Don’t use your balance transfer credit card for new purchases because any new purchases you put on the card will accrue interest at the regular interest rate rather than the card’s uber-low promotional rate.
How much can you save with a balance transfer?
Wondering how much you can potentially save with a balance transfer credit card? Well, we did a quick calculation to help illustrate the benefits of a balance transfer card:
Say you currently owe a balance of $3,000 on a rewards credit card that has a 19.99% standard annual interest rate. Every month, you diligently put $300 towards your balance. At that rate of repayment, it would take you 12 months to pay off your balance and you’d end up paying a total of $309 in interest!
Now, take the same example with a credit card that has a balance transfer promotion like the CIBC Select Visa*. Let’s assume you take that $3,000 balance from your old credit card and move it onto a new card with a balance transfer promotion of 0% for 10 months, a fee of 1% of the transferred balance (i.e. $30), and a rebated annual fee for the first two years. If you diligently paid off the balance in the allotted 10 months you would end up paying no interest at all on the transferred debt and all it would have cost you was $30. That’s an incredible savings of $279.