Balance Transfer Debt Consolidation
Many people use balance transfers as a type of mini, do-it-yourself debt consolidation loan. The idea is to open a new credit card account, with a low or zero percent interest rate, and transfer the balances from the higher interest, higher debt credit cards onto the new credit card. The idea is you will have one payment to make and pay much less in interest – hence you save a lot of money.
It is true that this method may save you money because the interest on the consolidated debt accrues at a lower rate or not at all. However, since the Credit Card Act of 2009, we have seen many creditors increase balance transfer fees from 2% of the balance to 5% of the transferred balance. While this may seem like a small difference, it can be quite large. Imagine you transfer $10,000; rather than add $200 to your balance (2% fee), you will add $500.
Another issue is that if the debt is not paid off before the introductory zero percent interest rate period is over, the debt consolidation loan becomes more expensive and any money you were saving is lost to interest.
Balance transfers present many concerns to people trying to manage credit responsibly and maintain good credit. The act of opening new accounts may negatively impact your credit and so can closing the other credit cards that you intend to stop using. If you decide not to close your other credit cards after you transfer the balances to a new account, you must have the discipline to stop using those cards. If you don’t, you will make your problem worse with more unmanageable debt.
Just to make it a little more confusing, if you close old cards immediately after the balance transfer, you may end up hurting your credit. Let’s say your old card has a $10,000 limit on it and you owe $8,000 – you are using 80% of the available credit limit. Now you open a new card with a credit limit of $10,000 and transfer the $8,000 to it because it has a 0% interest rate. Your credit usage rate is at 40% – still above the 30% that is optimum, but much better than 80%. If you close the original card, you will be right back at 80%. If you do not plan on using your credit for anything while you pay down the balance, then the usage rate may not matter.
Getting out of debt can be hard, frustrating work and sometimes it is difficult to know what the right choice is. Whether you are working on a do-it-yourself debt consolidation, considering bankruptcy, or contemplating using a debt management plan, it is very helpful to discuss the pros and cons of each scenario with a certified credit counselor. A counselor’s role is to listen to your needs and financial concerns and assist you in exploring and selecting the best option for your situation.
Published Jul 19, 2011.