How Balance Transfers Impact FICO Scores
By Eva Norlyk Smith, Ph.D.
October 25, 2011
Need money for a small home remodeling job, or to make much needed car repairs? Or do you simply want to use a 0 percent balance transfer offer to pay down high-interest credit card debt?
Before you apply for that new balance transfer card, make sure you know the ins and outs of how balance transfers impact FICO scores so you can minimize potential disadvantages.
Taking out a balance transfer may lower your FICO score in the short-term. But it can also help boost your score over time. Here are the three ways in which taking out a balance transfer will impact your credit score.
1. Opening a new account will shorten the average length of your credit history.
Any time you open a new credit card, it will shorten the average length of your overall credit history.
“About 15 percent of your FICO score takes into account the length of your credit history,” says Kim McGrigg, Community and Media Relations Manager at Money Management International. “Part of that average is all your accounts, so when you open a new account, obviously it affects the average length of credit history. If you close the old credit account, it will impact scores even more.”
The good news is that the impact on credit scores from opening a new account is small and relatively short-lived, as long as you follow good credit management practices on the new account. The key is to keep that old account open and use the card occasionally so it’s still active.
2. Credit inquiries will ding your FICO score.
Each time you apply for credit, a lender will check your credit history to determine if you’re a good credit risk. This will show up on your credit report as a “hard inquiry,” which can lower your score.
According to FICO, one credit inquiry every once in a while will have minimal impact, shaving as little as four to eight points off credit scores, and the effect, again, is relatively short-lived. However, frequent credit inquiries affect FICO scores proportionately more and the impact lasts longer.
3. Your credit utilization rate will suffer or improve, depending on how you use your balance transfer.
Next to paying bills on time, your credit utilization rate, or debt-to-credit ratio, is one of the most important components of your FICO score. It makes up a full 30 percent of scores.
And when you take advantage of a balance transfer offer, it can hurt or help your credit utilization rate, depending on how you use the loan.
For example, if you open a 0 APR balance transfer credit card in order to fund a small home remodeling project or large purchase that you plan to pay off gradually, your debt-to-credit utilization will increase, lowering your score. The impact may be blunted by the fact that your overall credit limit will also increase. However, if the loan is large enough, your score will still be negatively impacted until you pay down the loan.
On the other hand, if you take out a balance transfer to pay off existing high-interest debt on another credit card, your overall utilization will decrease. The amount of debt that you have will stay the same, but with the new credit card, you will have a greater overall credit limit, so the total debt-to-credit utilization will improve.
In addition, your within-card utilization may also improve, which help boost your score. For example, let’s say you apply for a new balance transfer credit card and get a card with a $10,000 limit. If you transfer $5,400 from a card with a $6,000 credit limit to a card with a $10,000 limit, you will lower your overall credit utilization — and you will lower the within-card utilization as well (from 90 percent utilization to 50 percent).
Your credit score may be temporarily dinged by opening a new account. However, because credit utilization accounts for a full 30 percent of your score and opening new accounts only affects 10 percent of your score, the overall impact will still be positive.
However, with that said, be aware that having extra credit available could also turn out to be a credit score liability if you’re not careful, warns McGrigg, especially if you keep your old account open and active.
“It’s true that if you don’t close the old account, you might actually have a chance to improve scores,” says McGrigg. “However, that’s only true if you don’t charge the account right up again. For many people, having an account with a zero balance is too tempting, and they might end up twice as much in debt as before.”
It’s also important that you don’t get complacent, warn experts. Transferring your debt to a lower interest balance transfer card may be a step in the right direction — but there’s still more work to be done.
“So many people think that [by] moving to a better account with a better interest rate, their problems are solved,” warns credit repair expert and financial literacy advocate Harrine Freeman, “But they’re really just moving money. Don’t get fooled by tricks and gimmicks. You don’t know what will happen in another year; you could move, you could lose your job. It’s best to just pay your debt the old-fashioned way.”