Paying Off Debt With a Balance Transfer

A balance transfer involves moving an existing debt balance from one vehicle to another. Borrowers can do this between loans and credit cards. Balance transfers can be an effective way to pay down expensive debt and save money on interest. But there are also some pitfalls to consider before you make the move. In this article, we highlight some of the features of balance transfers as well as some of the drawbacks of using this debt payment strategy.

How Balance Transfers Work

Balance transfers are often used to move money from one loan or credit card to another. Borrowers normally do so by moving high-interest debt to another debt vehicle with a lower rate, allowing them to save money on interest charges.

Say you’ve accumulated a large balance on a credit card with a high annual percentage rate (APR). If you transfer that balance to a new card with a lower interest rate, then a greater portion of your future payments can pay down the principal balance rather than paying interest.

Paying more toward your balance will help you pay off your debt more quickly and potentially save you a significant amount of money in the long run.

Balance Transfers on Credit Cards

How do you do a balance transfer on a credit card? You'll need to apply and be approved for a balance transfer credit card before anything else. Once you receive the card, you can initiate the transfer of all or part of your balance from your old card.

There are several ways to make the transfer:

• Write a check supplied by your new card company to pay off the old debt.
• Initiate the transfer by phone or online by giving your new card company the account number and other information for your old card, then indicate how much debt you want paid off and transferred to your new card.

Applying for a Balance Transfer Credit Card

Before applying for a new card, make sure you understand its terms, including interest rates for balance transfers and new purchases, in addition to how long any introductory rate lasts.

Calculate what you would save with a new card and its short- and long-term interest rates compared to your current interest rates. Additionally, compare both monthly payment amounts for your budget as well as long-term savings.

You can apply for a balance transfer card online and often get approved in a matter of minutes. You will need to provide your personal information, including your Social Security number (SSN) and your income.

Advantages and Disadvantages of Balance Transfers

Advantages of Balance Transfers

Transferring your balance from a high-interest debt to one with a lower interest rate allows you to pay down your balance faster. That's because more of your payments go toward the principal balance rather than interest. This also helps you save money because you aren't paying nearly as much interest as you would with a debt that comes with a higher interest rate.

You may consider moving all of your debt to the new vehicle, especially if you have enough credit available. For instance, if you have three credit cards and you receive a new card with a high credit limit, you may be able to transfer the balances on the other three cards. This consolidates all your debt into one balance with a single monthly payment.

Disadvantages of Balance Transfers

Although using a card with a 0% introductory period can save you money, there are risks. The first risk is transfer fees. Not all cards charge them, but those that do often have fees that range from about 3% to 5%. So, for example, if you’re transferring a balance of $5,000, then it could cost you $150 to $250.

Another risk is the potential for higher interest rates on balances after the promotional period (if any) ends. If you haven’t paid off your balance by then, you may find yourself paying more in interest rate, not less. Additionally, any late or missed payments on your new card could trigger the end of your promotional rate and cause an even higher penalty APR for a period.

Alternatives for Paying Off Debt

While a balance transfer can be a good way to pay off debt, it isn’t the only way. Borrowers have other options available to them if they want to pay off their debts.

One alternative is simply to earmark more money each month to pay down your credit card balance. If you have multiple cards, then pay at least the minimum due on each one and put any additional cash toward the card with the highest interest rate. Once that card is paid off, move on to the next highest interest card. This is sometimes referred to as the debt avalanche method.

Another alternative is to apply for a debt consolidation loan. This is a type of personal loan that often carries a lower interest rate than credit cards charge.

If you’re struggling to make the minimum payments on your debts, then you may want to consider looking into debt relief. This involves contacting your creditors and trying to negotiate new, more favorable terms, such as a lower interest rate or more time to repay.

You can negotiate on your own or hire a reputable debt relief company or a credit counseling service to assist you. Be aware that there are con artists who pose as legitimate debt relief organizations, so be sure to carefully review any companies that you’re considering.

Example of a Balance Transfer

Here's a hypothetical example to show how balance transfers work. Say you have a $3,000 balance on a credit card with a 15% interest rate. If you pay $250 per month, then it would take 14 months to pay off the balance plus over $270 in interest.

However, if you transferred that balance to a 0% interest card with a 3% transfer fee and made the same payments, then it would take only 12 months to pay off (including the $90 transfer fee), saving you nearly $181.

The Bottom Line

A balance transfer can be a useful tool to help you get out of debt and save money in interest in the long term, but it's risky. If you fail to pay off your balance by the end of the introductory period, or if you use your original line of credit to rack up more debt, you could add to your financial struggles. Consider consulting a professional financial advisor who can guide you through your best options for reducing your debt.