If you’re in credit card debt, you are probably all too familiar with how interest works. Any time you leave a balance on a credit card, the credit card issuer charges interest. The interest rate on credit cards can be as high as 15%, so a credit card balance of $500 can easily turn into $1,000 or even higher over time. Before you know it, the debt balance is so high that achieving debt-free status can seem hopeless.
If you think about all of the expenditures you made on your credit card such as groceries, gasoline, clothing and your daily latte — imagine paying a 15% premium on all of these items? That’s what is happening when you fail to pay off the credit card balance in full every month.
Interest is the main reason why credit card debt balances snowball into sky high levels. In order to prevent your credit card debt from growing, many consumers transfer the balance on their existing credit card to a new credit card that has a zero percent interest rate. This new credit card is called a
Why You Need the Zero Percent Interest Rate
A balance transfer card usually has a zero percent interest rate for a period of one to two years. After this period, the interest rate adjusts to a much higher level in line with the rate on a traditional credit card. On the credit card prospectus, it should disclose what the interest rate will be after the promotional period ends.
During the time of the zero percent rate, however, your debt will remain stable — it won’t increase because there are no interest charges. This is a key opportunity to pay off the balance and get out of debt. It gives you a chance to catch your breath.
Try to devote any extra funds towards the credit card balance before the promotional rate expires. Even if it’s just $20 a month here and there, this will still make a difference. During the zero percent rate period, you’ll be able to focus on the principal of the debt and not have to worry about paying interest. Interest just enriches the credit card issuer!
Remember, having credit card debt reduces your credit score. A low credit score will make it tougher to be approved for a mortgage or a car loan. Even if you are approved, the lender will likely charge you a higher interest rate because of your low credit score. On the flip side, if you have a high credit score, you’ll likely be rewarded with a lower interest rate on a mortgage or car loan. A lower interest rate means lower monthly payments.
Balance Transfer Cards Are for Debt Only – Nothing Else!
The zero percent interest rate only applies to the debt balance you transfer onto the card. If you start using the balance transfer card for common purchases like coffee, groceries or meals at restaurants, and you leave this balance on the card, the zero percent interest rate will not apply. Instead, a higher interest rate (say 15%) will kick in. The credit card issuer usually discloses what rate would apply if you used the card for anything beyond the debt balance transferred.
Remember, interest only applies when a balance is left on the card. If you used the balance transfer card for everyday purchases but paid off that balance in full upon the due date, no interest expense would apply.
To prevent the urge to use the balance transfer card on everyday purchases, don’t keep the credit card in your wallet. If you have to, literally cut up the balance transfer card to make sure it’s never used at the store. You can’t swipe the card if it’s cut in half!
How WIll Balance Transfer Cards Affect My Credit Score?
Typically, opening up multiple credit cards within a short period of time can hurt your credit score. Think about it: why do you need so many credit cards? From the credit bureaus’ point of view, it appears as if you’re hungry for credit and just a few steps away from splurging on thousands of dollars worth of purchases.
Still, only 10% of your credit score takes into account the frequency in which you open up new credit cards. With a balance transfer card, you are applying for and opening up a completely new credit card. You’ll have to enter in your personal information on the application, as well as the credit card numbers from the existing credit card that holds the balance you’re about to transfer. While opening up a balance transfer card may hurt your credit score in the short-term, it’ll help you pay off your debt faster, which will be beneficial for your credit score in the long run.
In fact, 30% of your credit score accounts for how much debt you have. That’s a much bigger weight than the 10% that relates to how many credit cards you open in a given period of time. Any small drop in your score that occurs from opening up a balance transfer card is worth it.
Watch Out for Balance Transfer Card Fees
Balance transfer cards may sound too good to be true. A zero percent interest rate, even for only one year, is a gift. But there is a caveat to the low interest rate perk: fees.
Some balance transfer cards charge a fee of 3% of the balance transferred. So if you transfer $1,000 onto the balance transfer card, you’ll pay a fee of $30. But think about the hundreds of dollars you may save in interest charges by having that zero percent interest rate? The balance transfer fee is usually worth it.