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).
Suggested Read: Pros and Cons of Owning Multiple Credit Cards
Before we dig deeper to understand the impact of credit card balance transfer on your credit score, let us first understand the process of balance transfer in detail.
What is a Balance Transfer and How Does it Work?
Banks and credit card issuers provide a 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 a 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, you can pay it interest-free or with a 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 Can 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 can lower your credit score:
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1. A Hard Inquiry on Your Credit Card
If in order to transfer the balance, you apply 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 how a credit inquiry can impact your credit score.
2. Increasing Credit Utilization Ratio
Your credit utilization ratio which represents your current debt versus the available credit limit is an important part of your credit score. It is a good habit to keep your credit utilization ratio low, preferably below 30%. When you transfer multiple balances to a single credit card and, at the same time, use 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 plays an important role in 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 have built up over the years, which could lower your credit score.
How a Balance Transfer Can Improve Your Credit Score?
Balance transfer not only impacts your credit score negatively, but sometimes it can help you improve your credit score. Here are the ways through which balance transfers can be helpful for you:
1. Increasing Available Credit
When you apply for a new credit card for a 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. Decreased Credit Utilization Ratio
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 that 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 pay off 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 a 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 a new credit including loans 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.
- 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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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:
- Personal loan: A personal loan can offer a structured debt repayment plan that doesn’t affect your credit utilization ratio.
- Top-up home loan: Top-Up loan is a facility provided by banks, housing finance companies and other financial institutions that allow you to borrow a certain amount of money over and above your home loan.
Choosing a 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 advantage and take immediate steps to assess how to avoid the need for more such cards in the future. Make timely payments on the new card, and keep your old credit cards open for long-term improvement in the credit utilization and average credit age.
Suggested Read: How credit card impacts your credit score?
Please note that Balance Transfers do not change the past, any missed payment on the old account will still affect your credit score.