You've got just the ticket to blitz your high-interest holiday credit card balance: a 0 percent balance transfer deal. But how do you make sure you don't mess up and dig yourself deeper in debt?
“Balance transfers can be a terrific tool if used wisely,” says Rod Griffin, director of public education for Experian.
Balance transfer offers typically allow consumers with good credit to move a balance from a high-interest credit card to one with no interest for a period of six to 18 months. But to get the maximum benefit and actually end up better off financially, you need to avoid these six common mistakes.
1. Failing to read the fine print. Before applying for a balance transfer card, it's crucial to read the terms and conditions carefully, says Jana Castanon, community outreach coordinator for Apprisen, an organization that offers debt counseling and financial education. Find out which mistakes (such as late payments) would jeopardize your 0 percent interest rate and what default interest rate your card would revert to, Castanon says.
2. Not paying attention to balance transfer fees. Most balance transfer offers come at a cost; typically, about 3 or 4 percent of the amount you transfer gets tacked onto your total, says John Ulzheimer, a credit expert at CreditSesame.com. A consumer who transfers an $8,000 card balance might pay about $240 to $320 in fees, which is then added to the transferred balance.
“That's not chicken feed,” Ulzheimer says.
So, do the math and look at your situation to see if the fee is worth it. For many consumers, it is, Ulzheimer says.
“If you compare that to the amount of interest you're not going to be paying, it's still tilted pretty heavily in your favor,” he says.
However, if you owe a large amount and are struggling just to make the minimum payment, the fee may not be worth it because there's a good chance you won't get your balance paid off during the promotional period anyway, Ulzheimer says. In that case, you might want to explore other options, such as a home equity loan or credit counseling with a debt management plan to reduce your interest rate and modify your payback period.
3. Racking up more debt. Many balance transfer offers contain two parts: 0 percent interest on the balance you transfer — and 0 percent on new purchases for a limited time. That second component can lead you astray.
“Make sure you don't get tempted by that and start making charges,” Griffin says. “You can dig yourself deeper in debt and defeat the purpose of the balance transfer.”
That happens to far too many consumers who revert to their old pattern: charge a lot, pay a little and charge some more, Ulzheimer says. So, if your balance transfer deal offers interest-free purchases, Ulzheimer recommends putting that out of your mind.
Some consumers also make the mistake of reaching for their old card, which is suddenly empty, and maxing it out again.
“That's the pattern that gets people into deep debt trouble,” Griffin says.
To stay on track financially, Ulzheimer recommends sticking with your debit card for purchases while you pay down your credit card balance.
4. Closing your old card. Even after you've moved your debt off your old card, don't close it. That could hurt your credit score, Griffin says.
Why? Closing a card can throw off an aspect of your FICO score called credit utilization, which accounts for 30 percent of your score, according to myFICO.com. Credit utilization rate is the amount of available credit you're using — the less, the better. If you have a credit limit of $10,000 spread out over two cards and you owe $5,000 on one card, your credit utilization rate would be 50 percent. Close one card and your credit utilization rachets up fast. Credit experts recommend keeping your utilization at 30 percent or less (ideally under 20 percent).
If closing a card would negatively affect your utilization ratio, Ulzheimer recommends simply shredding the card (to help you avoid temptation), but keeping the account open. If you ever want a replacement card, just call your issuer, he says.
“They will be more than happy to send you one.”
5. Breaking the rules. Balance transfer deals can seem like a panacea for debt. After all, you get interest-free money for up to a year or more. But there is a dark side: If you mess up by making a late payment, going over the credit limit or breaking another rule, that 0 percent interest rate can get yanked away, Castanon says. And it could get replaced by the default rate, which could be higher than the rate on your old card. If that happens, you could end up in a worse spot than if you had stayed with your current card.
6. Not paying off the debt before the 0 percent period expires. To get the maximum benefit from a balance transfer, you need to get your balance to zero before the introductory period ends. If you still owe a hefty amount when the clock winds down on your deal, your balance will begin growing again as interest charges get tacked on.
“You didn't save yourself any money, and now you're paying interest again,” Ulzheimer says.
Before you apply for a balance transfer card, take a realistic look at your income and expenses to learn if you can pay down the amount of debt you have in the amount of time the 0 percent deal lasts. If it's going to be a stretch, you may want to consider transferring only part of your balance to a new card and keep the rest on your old card, especially if it has an interest rate that's lower than a balance transfer card's default rate.
If you're set on transferring your entire balance, shop around for the offer that gives you the longest period at 0 percent, Ulzheimer recommends.
“It's basically buying you more time,” he says.