A balance transfer is an extremely effective way to cut down the amount of interest you pay on your debt. Applying for a balance transfer does require a hard inquiry on your credit, which is likely to impact your credit score.
But there’s no reason to freak out.
How Your Score Will Be Affected
According to FICO, a hard inquiry on your credit results in a score drop of about five points or less. Then, after a few months of appropriately using your credit by paying your debts on time, you’re likely to see your score bounce back up.
In fact, you may even see your score increase. This is because while new credit makes up 10% of your credit score, the amount you owe accounts for 30%. A huge component of the amounts you owe isn’t necessarily dependent on the actual dollar amount, but rather on your credit utilization ratio. To find this ratio, you divide how much you owe by your total available credit limit (across all cards).
Let’s say you had $7,500 in credit card debt, and it was your only debt. You only have one credit card with a $10,000 limit. You applied for another card that was offering you a reduced interest rate to entice you to do a balance transfer, and you took it. That card gave you an additional credit line of $5,000.
There was a 3% fee to transfer the $7,500, so now your total debt is $7,725. Where your credit utilization used to be 75%, now it is only 52%. You may owe a bit more money, but since your credit utilization went down, you’re likely to see your credit score jump up a little bit. The $225 extra will probably end up saving you money, but let’s walk through how.
How a Balance Transfer Can Save You Money
The fact that you now owe an additional $225 may make you cringe, but in all reality, the balance transfer will save you money long-term. In this example, you were offered an introductory interest rate of 0% for 18 months and then 15% APR after the promotional period ends. You currently pay 18% APR on your $7,500 debt and make monthly payments of $200.
If you don’t take the balance transfer and make the $200 monthly payment, it will take you 56 months and cost $3,604 in interest to get debt free.
If you take the balance transfer and make the same $200 monthly payment, you could be debt free in 43 months and only pay $900 in both interest and fees (that $225 to transfer the balance). You could even transfer the balance at the end of your first promotional period to another 0% APR offer with no fee for 15 months and be debt free in 40 months and pay $423 in interest and fees.
That initial hit on your credit score and $225 fee will save you $2,704 in interest with one balance transfer or $3,181 with multiple balance transfers.
Well worth the price.
When You Might Want to Wait
If you credit score falls below the “good” range, which would mean your score is below 680, it may be wise to wait before applying for a balance transfer. Financial institutions generally will not accept your application if you’re at 679 or below, but they will have to complete the hard inquiry in order to get that information. That means your score is still likely to drop, but you won’t be seeing any of the rewards of decreased credit utilization.
If you’re close to the cutoff, waiting until you hit that magic 680 number may be a good idea. While you’re waiting, be sure to do things that are likely to improve your score, like:
- Paying at least your minimum payments on time every month.
- Paying all your other bills on time so nothing delinquent pops up on your credit report.
As you pay your minimum payments on time every month, your creditor likely be reporting positive information to the credit reporting agencies. At the very least, they won’t be reporting negative information.
If you make more than the minimum payment, your balance will go down faster which will lower your credit utilization, and we’ve already seen how that positively affects your score.
After your score increases, you’ll be more likely to qualify for the balance transfer with low or no interest rates. At that point, taking the small hit will be worth it.
Another time you may want to wait before applying for a balance transfer is if you are thinking about taking out a mortgage in the near future. This is one of the biggest purchases you’re likely to make in your life. The higher your credit score when you apply, the lower your interest rates will be, so even a small hit from a hard inquiry could increase your interest rates.
Go For It
If you qualify and are not thinking about making a massive purchase in the near future, taking the temporary, small hit on your credit score is more than likely worth the savings. Just be sure to pay at least the minimum due every month once you’ve made the balance transfer; otherwise your interest rates will jump back up, negating the advantage of this strategy.
A good credit score is something to be leveraged. The entire reason you want one is to enable you to save money. While it might be nerve-wracking to watch it decrease slightly, paying more interest than you have to is a bigger cause for concern.