One False Move Can Ruin a Balance Transfer
By Eva Norlyk Smith Ph.D.
April 29, 2013
I got an offer for a 0 percent balance transfer card. It's for 12 months. I have $5,400 now on a card that has a 16 percent APR, so I think that this would be a good move. I've never moved a balance, though, and I imagine there are ways the credit card company will make money off of me. So what am I not thinking about? How can I tell if this is a good move? — Fred
As they say, there's no such thing as a free lunch, so you're right to be cautious. Banks are in the business of making money, and 0 percent APR balance transfer offers are no exception. While these may seem like free loans, if you don't play your cards right, the banks end up making more money than they give up.
Answering these questions will help you decide if this transfer is a good move.
- What is the balance transfer fee? Most 0 percent APR offers come with a fee, typically around 3 percent. So for each $1,000 you transfer, you pay a $30 fee. In your case, the fee would amount to $162 if you transfer the full balance.
- How much would I save? To see if the balance transfer is worth the trouble, calculate what you'll save in interest charges. Let's assume you pay off the balance in a year (which is what you were planning to do, right?). If you kept the balance on your existing card, you'd pay $480 in interest. You'd pay nothing in interest on the balance transfer card. So subtract the $162 balance transfer fee, and we're talking a savings of $318.
- How much do I have to pay to save money on interest? If you transfer the $5,400 balance, plus the balance transfer fee of $162, your new balance will be $5,562. In order not to incur interest during the 12-month promotional period, you will have to pay 12 equal installments of $463.50. If you cannot afford to pay that much every month for a year, then you will have some balance left over that will be subject to a much higher interest rate once the 12-month promotional period expires.
- What will the purchase APR be after the 0 percent period? OK, let's consider the possibility that you may not, in fact, pay the balance off in a year. Most balance transfer cards come with higher-than-average purchase APRs, as high as 22.99 percent. If you were wondering exactly how banks make money off 0 percent balance transfers, this is one way. Many consumers taking out a balance transfer won't be able to pay the balance off before the 0 percent APR offer expires, so they get stuck paying high interest rates on the remaining balance.
- What will the remaining balance be on the card once the 0 percent APR offer expires? To determine this, simply multiply your estimated monthly payments by 12. Let's say that you can only pay $200 per month on the new card. That's $2,400 in a year, so you'd end up with a balance of $3,000 at the end of the promotional period. Add the $162 balance transfer fee, and you'd be looking at a remaining balance of $3,162. That's not as bad as the $5,400 you had originally — but remember that you'll still have to pay off the $3,162 at a higher interest rate.
- Will I be worse off? Worst-case scenario, if you end up with a card charging 22.99 percent at the end of the 0 percent offer, you'd now be paying 7 percent more in interest on the remaining balance. For each $1,000 remaining on the card, you'd now be paying about $230 in interest a year, instead of $160. The longer you keep a balance on the new card, the more you will undermine those balance transfer savings.
- Will this affect my credit? Applying for a new credit card could also affect your credit score. Getting a new credit line will help your score in the long run, if you keep balances low in relation to the credit limit. On the other hand, applying for new credit card, particularly if done frequently, can hurt your score. If you carry high balances (in relation to your credit limit) for a long time, that can hurt scores even more.
- Do I have the discipline to take on extra credit? If you still decide the transfer is worth it, you need to ask yourself the hardest question of all: Will taking on more (and cheap) credit cause you to spend more?
If knowing that you're saving money will cause you to make more impulse buys, you'll be canceling out your savings.
In short, when used with caution and discipline, 0 percent balance transfer offers can save you a good amount of money on credit card interest only if you are able to repay the entire amount during the zero interest promotional period.
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