Credit card balance transfer pitfalls to be aware of
Canadian credit card debt recently totalled more than $100 billion for the first time, according to credit monitoring agency Equifax.
With debt mounting, many are wondering whether or not they should be doing a credit card balance transfer. A credit card balance transfer is when you move an outstanding balance from one or more credit cards to another credit card (typically with a lower interest rate).
This is often done as a strategy to save on interest costs and consolidate debts, making it easier to manage and pay off the outstanding balances.
But what are the pitfalls and benefits of doing these credit card balance transfers? Let’s find out here.
PITFALLS OF A CREDIT CARD BALANCE TRANSFER
A balance transfer can be a helpful strategy to consolidate and pay off credit card debt, but it’s important to be aware of potential pitfalls before proceeding. In Canada, some common balance transfer pitfalls include:
- Balance transfer fees: Some credit card issuers charge a balance transfer fee, typically ranging from one to five per cent of the transferred amount.
- Introductory interest rates will increase: Many balance transfer credit cards offer low or zero per cent introductory interest rates for a limited time, typically between 6 to 18 months. But keep in mind that once this period ends, the interest rate may jump to a much higher standard rate.
- Loss of interest-free grace period: Many credit cards with balance transfer offers may eliminate the interest-free grace period on new purchases. This means you could start accruing interest immediately on any new purchases.
- Impact on credit score: Applying for a new credit card and transferring a balance can temporarily lower your credit score due to hard credit checks.
- Limited balance transfer amount: Some credit card issuers may limit the amount you can transfer, which might not be enough to cover your existing debt.
- Ineligibility for rewards or promotions: While completing a balance transfer, you may not be eligible to earn rewards or take advantage of promotional offers on the new card.
- Balance transfer deadlines: Some credit card issuers require that you complete the balance transfer within a certain period after opening the account. Missing this deadline could result in a loss of the promotional interest rate.
To avoid these pitfalls, carefully review the terms and conditions of any balance transfer offer, and create a plan to pay off your transferred balance before the promotional period ends. Also, try to avoid making new purchases on the card until the transferred balance is paid in full.
POTENTIAL BENEFITS OF A CREDIT CARD BALANCE TRANSFER
Balance transfers can also offer several benefits if used responsibly and strategically. Some of the main advantages and how it could help your credit situation include the following:
- Lower interest rates: Many balance transfer credit cards offer low introductory interest rates for a limited time. This can help you save on interest costs and potentially pay off your debt faster.
- Consolidation of debt: Transferring multiple credit card balances onto one card can simplify your finances by consolidating your debt. This makes it easier to manage your payments and track your progress in paying off the debt.
- Improved credit score: Over time, reducing your credit utilization ratio and paying off debt can have a positive impact on your credit score. This can make it easier to qualify for loans, mortgages, and other financial products in the future. Your credit utilization ratio is a measure of how much of your available credit you are currently using, expressed as a percentage. It is calculated by dividing your total credit card balances by your total credit limits. Suppose you have two credit cards, one with a balance of $300 and a limit of $1,000 and another with a balance of $200 and a limit of $2,000. Your total credit card balance is $500 ($300 + $200), and your total credit limit is $3,000 ($1,000 + $2,000). To calculate your credit utilization ratio, divide the total balance by the total limit: $500 / $3,000 = 16.67 per cent. A lower ratio is generally better for your credit score.
- Opportunity to switch issuers: If you’re not satisfied with your current credit card issuer, a balance transfer can be an opportunity to switch to a new issuer with better customer service, rewards, or other features.
- Financial breathing room: A balance transfer with a low introductory interest rate can provide temporary financial relief, allowing you to focus on paying down your debt without the pressure of high-interest charges.
To maximize the benefits of a balance transfer, it’s important to have a clear plan for paying off the transferred balance before the promotional interest rate expires. Also, consider avoiding new purchases on the card until the balance is paid off, and make sure to pay your monthly statement on time to avoid late fees and potential interest rate increases.
Remember that a balance transfer can be a useful tool to manage and pay off credit card debt, but it’s important to carefully consider the terms and conditions, fees, and interest rates before proceeding.
Christopher Liew is a CFA Charterholder and former financial advisor. He writes personal finance tips for thousands of daily Canadian readers on his Wealth Awesome website.
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