Do you have multiple credit cards with balances and you're trying to get out of debt in the most efficient way possible? You're not alone. It can feel like you're not moving the needle on your overall debt balance.
Under the right circumstance, a balance transfer can be a great tool for consolidating debt and paying it off within a short period of time. But again, only under the right circumstances. Let's review the Pros and Cons of doing a balance transfer.
Pros of Balance Transfers
Lower Interest Rates. Many credit cards will offer a lower or 0% interest rate on balance transfers for a fixed period of time. This will allow you to save money on interest each month.
Consolidated Payments. Consolidating your debt onto one credit card will make it easier to to manage your debt payments.
Credit Score Increase. If you stay diligent and commit to paying off the debt (and not add additional debt to your credit cards) during the promotional period, your overall debt balance will be lower. This will improve your debt utilization ratio, which accounts for 30% of your credit score.
Cons of Balance Transfers
Promotional Period. The promotional periods are typically short periods such as 12 or 18-months. If the balance is not paid off during the promotional period, the remaining balance can be subjected to the higher regular interest rate.
Balance Transfer Fees. Some credit cards will charge a balance transfer fee, which can be a percentage of the balance or a flat fee.
New Debt. The balance transfer method is only useful if you stop adding on new debt.
Not all balance transfers are successful. I've done several credit card balance transfers without committing to stop using my credit cards or, even worse, I didn't commit to making the needed payments to get to pay off the balance during the promotional period. This leads me to discuss the math that we need to look at when considering a balance transfer.
Let's Examine the Numbers
Let's say you have received a credit card balance transfer in the mail to consolidate up to $10,000 at 4.5% interest with a $0 balance transfer fee for 15-months. After the 15 month promotional period, the balance will be subjected to a 19% interest rate. You currently have the following credit card balances:
$3,000 at 17.99% interest
$1,450 at 21.99% interest
$4,200 at 19.99% interest
$8,650 total
You decided to take advantage of this balance transfer offer since the 4.5% interest rate is significantly less than your current credit card rates. You also want to pay the entire balance off within the 15-month promotional period so that you are not subjected to the 19% interest rate, which is higher that your current average interest rate of all of your debt. So how much will you have to pay each month to pay it off in 15 months?
$594.12 per month
Here's a great balance transfer calculator from Bank Rate to see what your monthly payment would be, given your current circumstances.