When it comes to overdue bills on credit cards, a balance transfer is one of the most preferred and cost-effective ways to manage the debt. Under this, you pay off the balances on your existing credit card by transferring them to another credit card account. A lot of users ask how a balance transfer affects their credit score- whether it hurts their score or improves it. Let’s find out.
A balance transfer helps you pay off your debts faster and, if you are carrying debts on multiple credit cards, consolidating them into a single card will surely reduce the risk of missed payments, which would negatively impact your score later. So, in this way, it helps you maintain a good score, if not improve it. However, balance transfers can hurt your credit score by increasing your single-card utilization, lowering your length of credit history and adding a hard inquiry to your credit report (if you are applying for a new card to transfer the balance).
Before we dig deeper to understand the impact of credit card balance transfers on your credit score, let us first understand the process of balance transfers in some detail.
What is Balance Transfer and how does it work?
Banks and credit card companies provide the balance transfer facility that allows you to move existing credit card debts to a new account. The bank may offer a promotional interest rate, also known as teaser rate, that is much lower than its usual finance charges but only for a limited period of time.. Debt from multiple sources can be consolidated into one monthly payment, to be paid down interest-free or with lower interest burden over 12, 15 or 18 months depending on the card.
Remember, you can avoid credit card interest on most cards by paying your balance on time and in full every month. But if you are already in debt and have a plan to pay it off, a balance transfer may be one way you can strategically reduce the amount of interest you pay.
How a Balance Transfer could hurt your Credit Score?
It is important to know that the actual process of transferring a balance to a new credit card has no effect on your credit score.
However what you do after transferring the balance can end up negatively affecting your credit score. Following are some of the ways in which a balance transfer credit card could lower your credit score.
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1. A hard inquiry on your credit card
If, in order to transfer the balance, you are applying for a new credit card, the lender conducts a hard credit inquiry on your credit report. Each hard credit inquiry lowers your credit score by a few points. In the majority of the cases, you need not worry about how credit inquiries affect your credit score- but if you are on the verge between average credit and good credit, it might be worth considering whether a credit inquiry will keep you from reaching the next level.
Also Read: Why my CIBIL score is important?
2. Increasing credit utilization ratio
Your credit utilization ratio which represents your current debt versus your available credit, makes an important part of your credit score. It is a good habit to keep your credit utilization ratio low. When you transfer multiple balances to a single credit card and, at the same time, use up the credit limit freed from the other cards, your credit utilization will shoot up which will lower your credit score.
3. Shortening your credit history
Your length of credit history accounts also make an important part of your credit score. In case you close an old credit card after transferring the balance, you might eventually lose some of the credit history you would have built up for over the years, which could lower your credit score.
How a Balance Transfer can help your Credit Score?
1. Increasing available credit
When you open a new credit card for balance transfer, the amount of available credit under your name increases which eventually reduces your credit utilization ratio, which is a great way to improve your credit score. But this is possible only if you keep the limits on other credit cards free.
2. Consolidating debt into a single monthly payment
Moving your balances to one credit card will make it easier to keep track of your debt and make payments on time. Avoiding late payments is perhaps the most important thing you can do to strengthen your credit.
3. New card will help decrease credit utilization
When you get a new credit card to transfer the balance, you will get an additional credit limit. Moving multiple debts to a new credit card could decrease your overall credit utilization ratio or percentage of the available credit you are using. The lower your credit utilization ratio the better, because a low rate shows the lenders you are not racking up the debt you can’t repay.
Is Balance Transfer a good idea?
Let’s understand this with an example:
Let’s say you are carrying a balance of Rs. 70,000 on a card that charges 15% interest, and your goal is to pay it off in the next 6 months. If you just leave the debt on your card while you pay it off, you could expect to pay approximately Rs. 10,000 in interest. But if you choose to transfer the balance to a card with 0% APR for 12 months, then you will save this much extra interest. Also keep in mind that most cards charge a balance transfer fee of 2.5% to 5% of the transferred amount
When you transfer a balance, you are paying off existing debt with a new credit card. Assuming you move the debt to a card with a lower interest rate, it will cost less money to maintain that debt going forward. That means you can devote more money to paying down the principal on the debt, rather than paying interest.
However an important point to note here is that after your teaser period of 0% APR ends, your new card will start levying the usual interest charges as prescribed by the bank.
What to do after a Balance Transfer?
To make sure you don’t fall into debt there are other steps you can take once a balance transfer is complete:
- Avoid closing old credit cards- It is generally best to keep old or unused accounts open—especially your oldest account. However if an old card charges an high annual fee that you can’t afford, closing it may be the best option
- Avoid applying for new credit- Limit the number of hard inquiries on your credit report and only apply for new credit including loan when you absolutely need to
- Avoid making purchases with your balance transfer card- The best use of a balance transfer credit card is to pay off debt. Adding to that debt could make it more difficult to get rid of the balance before your promotional 0% APR offer ends. After the promotional APR period ends, your APR will jump and if interest accrues on an outstanding balance, you could negate any savings the promotional period provided
- Set up autopay and create a budget- Make all your monthly payments on time to maintain your credit score, as credit score calculations generally weigh your payment history quite heavily. To avoid accruing additional debt, make a budget and regularly track your spending
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What are alternatives to Credit Card Balance Transfer?
A balance transfer can help you get out of debt, but it is not the only answer. Based on your situation,one of these options may be a better fit:
|Alternatives to Credit Card Balance Transfer|
Choosing balance transfer facility can help in debt-management, but be cautious when exploring new balance-transfer card options. Overall, it is best to use a new balance-transfer card to its fullest advantages and take immediate steps to assess how to avoid the need for more of such cards in the future. Make timely payments on the new card, and perhaps keep the old card(s) open for long-term improvement to the credit utilization and average credit age.
Please note that Balance Transfers do not change the past, any missed payment on the old account will still affect your credit score.