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Thinking about moving high-interest credit card debt to a card with a lower rate — or, better yet, a 0% interest period — by doing a balance transfer? This move can save you hundreds of dollars while making it easier to pay down what you owe.
Balance transfers won't hurt directly, but applying for a new card could affect your credit in both good and bad ways.
As the cornerstone of a debt-reduction plan, a balance transfer can be a very smart move in the long-term. Here's what you need to know about how a balance transfer could affect your credit score.
Applying for a new credit card to transfer your balance will result in a on your credit report. A hard inquiry will shave a few points off your score initially, and it will stay on your credit report for up to two years.
Opening a new card also affects the length of credit history. A new card can reduce the average age of your credit, which can knock points off your score. If you have few credit cards, it will have a bigger impact than if you have many.
Using a balance transfer to pay down debt and use credit responsibly going forward should mitigate or even cancel out the short term dings in the longer term.
The simple act of performing a balance transfer isn't going to affect your credit score much, if at all. The key to changing your credit score is to use the transfer to reduce your debt — both in dollar terms and as a percentage of your available credit. Eliminating debt sends the kind of signals that result in better credit scores.
Every dollar you don't have to pay in interest is a dollar you can use instead to pay down your debt. That allows you to shrink your debt faster — and shrinking your debt is good for your credit. The amounts you owe account for 30% of your FICO credit score, and the dollar amount of your debt is a factor there. Another factor is your, or the percentage of your available credit that you're using.
A good rule of thumb is to keep your credit utilization ratio below 30% at all times — both on a per-card basis and across all of your cards. Adding a new card with a new line of credit reduces your overall credit utilization.
Let’s say a consumer has two credit cards:
This consumer has a 40% utilization ratio on Card A, a 33% utilization ratio on Card B and an overall utilization ratio of 37.5% ($3,000 divided by $8,000). On each card as well as overall, this consumer’s debt is over the 30% ceiling.
Now say this person gets a (Card C) with a $6,000 limit and moves all the other debt to it. This person now has a utilization of 0% on Card A, 0% on Card B, 50% on Card C and 21% overall.
On the whole, this will look better on the consumer's credit report. And, of course, the transfer has put this person in a position to pay down that $3,000 debt more quickly because of the interest savings.
A balance transfer should save you money. If it doesn't do at least that much, there's really no point in doing one.
For example, let’s say you’re carrying a balance of $10,000 on a card that charges 15% interest, and your goal is to pay it off in the next 12 months. If you just leave the debt on that card while you pay it off, you could expect to pay about $830 in interest. But move it to a card with a 0% APR for 12 months, and interest would cost you nothing.
Keep in mind that most cards charge a balance transfer fee of 3% to 5%. In this example, a 3% fee would cost you $300, so you'd come out $530 ahead.
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'll 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.
When thinking in terms of your credit score, it's important to understand what a balance transfer does not do:
Simply put, a balance transfer won't change anything that's already on your credit report. But it sets you up for moves that can improve your credit down the road, plus it can save you money in the near-term.
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