Balance Transfers: The Good, The Bad and the Ugly

By February 14, 2013Credit Cards, Debt, Revolving Debt

Banks and credit card companies always make balance transfers sound so attractive. But, there is something that those flyers and applications leave out. Depending on your situation a balance transfer may hurt – not help – your credit score.

The Good

There is some truth to the advertising. Balance transfers can be good and they can improve your credit score. Thirty-percent of your FICO score is determined by your “credit utilization rate” or how much of your credit card limits you are using. The less debt, compared to your limit, the better (using $2,000 on a $10,000 card is good, while using $7,000 on a $10,000 card is bad).

There are a few ways to use a balance transfer to lower your credit utilization rate and therefore, improve your FICO score. One strategy is to open a new card and spread out your debt among your credit cards. For example, if you have a total of $6,000 in credit card debt on two cards, each with a credit limit of $5,000 per card and a balance of $3,000 on each card – your credit utilization rate is 60%.  If you open a new card, with a $5,000 credit limit, and spread out your debt to $2,000 per card, your credit utilization rate will drop to 40% ($6,000 of debt versus $15,000 credit limit).  That’s a good thing.

Another scenario that could help your score is to simply transfer your entire balance from one card to a new card, if the new card has a higher credit limit. Keep in mind that any time you apply for new credit, your FICO score will be negatively impacted. However, these inquiry “hits” to your score will quickly rebound and may be worth it in the long-run.

The Bad

If you carry a balance of $2,000 on a credit card with a credit limit of $5,000, your credit utilization rate is 40%. If however, you transfer that balance to a new card that only has a credit limit of $3,000, than your credit utilization rate will jump to 66% – and that’s not good. The savings in interest will not be worth the hit to your credit rating.

You may consider a balance transfer to help improve the credit score of your spouse. Perhaps moving some of their debt to one of your cards could help lower the credit utilization rate for your spouse and for the two of you as a couple. However, assuming someone else’s debt is risky and once the transfer is made into your account, you become solely liable. To protect yourself, consider making your spouse a joint account holder to ensure that they remain legally responsible for some of the debt.

The Ugly

It is possible that the balance transfer may not actually work. There have been several stories in the media about banks failing to complete a balance transfer, renegotiatng the original offer and/or re-evaluating the borrower’s current credit limits. Not only can you end up wasting too much time on the phone trying to sort out the issue, but some banks may take the opportunity to review your credit and make decisions that are not in your favor, like reducing your credit limit, therefore raising your credit utilization rate.

Also, if you transfer the full balance of one card onto a new card, don’t immediately close your old accounts. Keeping those older credit limits will help your overall credit score because it will lower your credit utilization rate.  Plus, long-standing accounts reflect well on your credit.

Bottom line, before you call that 1-800 number to secure a 0% APR on a balance transfer, study your current credit card balances to determine if the offer will help you, or hurt you in the long run. If properly researched, a strategic balance transfer can be good for your credit, but if you rush in, it might get ugly.

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