Credit Cards: What is a Balance Transfer and How Does it Work?

A balance transfer involves moving debt from one credit card to another to take advantage of lower interest rates.

Key points on balance transfers

• Interest Rates: Look for cards with low or 0% introductory APR for balance transfers.
• Transfer Fees: Be aware of any fees associated with the balance transfer, typically 3-5% of the transferred amount.
• Credit Limits: Ensure the new card’s credit limit is sufficient to cover the debt you wish to transfer.
• Introductory Period: Aim to repay the transferred balance within the introductory period to avoid high interest rates afterward.
• Eligibility: Check if the balance transfer is allowed between the cards you have. For example, you can’t transfer your balance from one Lloyds Bank credit card to another. There are also some store cards you can’t balance transfer from, so check with your provider beforehand. Another example, as RBS and Ulster Bank are part of the NatWest group, you can’t transfer from any of them to NatWest.

What is a Balance Transfer?

Definition

A balance transfer involves moving outstanding debt from one credit card to another. The primary purpose is to consolidate debt or benefit from lower interest rates offered by the new credit card.

How It Works

Here’s an example of how a transfer works:

• Offer Selection: Choose a credit card that offers a balance transfer with a lower interest rate or an introductory 0% APR (Annual Percentage Rate) for a specified period.
• Transfer Process: Apply for the new credit card and request a balance transfer, providing details of the existing debt to be moved.
• Approval and Transfer: Upon approval, the new credit card issuer pays off the old debt, and the balance is transferred to the new card.
• Repayment: Repay the transferred balance under the terms of the new credit card, ideally within the introductory period to avoid higher interest rates.

How Much Money Can You Save With a Balance Transfer?

Cost Savings: By transferring to a card with a lower interest rate or a 0% introductory APR, you can save on interest charges, reducing the overall cost of your debt.

Faster Repayment: Lower interest rates mean more of your payments go towards reducing the principal balance, allowing you to pay off debt faster.

How long does a balance transfer take?

The time it takes to complete a balance transfer can vary, but typically it ranges from a few days to a few weeks. Factors that affect the transfer time include the policies of the credit card issuers involved and the efficiency of the payment processing systems.

Benefits of Balance Transfers

Lower Interest Rates

• Cost Savings: By transferring to a card with a lower interest rate or a 0% introductory APR, you can save on interest charges, reducing the overall cost of your debt.
• Faster Repayment: Lower interest rates mean more of your payments go towards reducing the principal balance, allowing you to pay off debt faster.

Debt Consolidation

• Simplified Payments: Consolidating multiple debts into one credit card can simplify your finances by reducing the number of payments you need to manage each month.
• Single Due Date: With all balances on one card, you only have to remember one due date, decreasing the likelihood of missed payments.

Potential Pitfalls of Balance Transfers

Balance Transfer Fees

• Cost Consideration: Many credit cards charge a balance transfer fee, typically 3-5% of the transferred amount. This fee can offset some of the interest savings, so it’s important to factor it into your decision.

Introductory Periods

• Time Limitation: The lower or 0% APR typically lasts for a limited time, such as 6 to 18 months. After this period, the interest rate may increase significantly.
• Repayment Plan: Ensure you can pay off the transferred balance within the introductory period to avoid high interest charges.

Credit Limit

• Transfer Limits: The credit limit on the new card may restrict the amount you can transfer. Ensure the limit is sufficient to cover your existing debt or the portion you plan to transfer.

Impact on Credit Score

• Credit Inquiry: Applying for a new credit card involves a hard inquiry on your credit report, which can temporarily lower your credit score.
• Credit Age: Opening a new account can reduce the average age of your credit accounts, potentially impacting your credit score.

Steps to Execute a Balance Transfer

Step 1: Review Your Current Debt

• Evaluate Interest Rates: Check the interest rates and balances on your existing credit cards.
• Assess Fees: Be aware of any fees associated with your current cards and the potential transfer.

Step 2: Shop for Balance Transfer Offers

• Compare Cards: Look for credit cards that offer low or 0% introductory APR on balance transfers.
• Read Terms: Carefully read the terms and conditions, including the duration of the introductory period and any balance transfer fees.

Step 3: Apply for a New Credit Card

• Eligibility Check: Ensure you meet the eligibility criteria for the new card.
• Application Process: Complete the application, providing necessary financial and personal information.

Step 4: Request the Balance Transfer

• Provide Information: Supply details of the existing debt you wish to transfer.
• Approval: Wait for approval from the new credit card issuer.

Step 5: Manage Your Repayments

• Monitor Payments: Keep track of your payments and aim to pay off the balance within the introductory period.
• Avoid New Debt: Refrain from accruing new debt on the old card to prevent further financial strain.

Balance transfers can be a valuable tool for managing and reducing credit card debt, but they require careful consideration of fees, interest rates, and repayment terms.

Example of a Balance Transfer

John has a credit card debt of £3,200 on a card with a 29% APR. He decides to transfer this balance to a new credit card offering a 0% APR for 22 months with a 2.99% balance transfer fee.

Details of the Balance Transfer

1. Current Debt:
   • Amount: £3,200
   • Current APR: 29%
2. New Credit Card Offer:
   • Introductory APR: 0%
   • Introductory Period: 22 months
   • Balance Transfer Fee: 2.99%

Calculation of Balance Transfer Fee

• Balance Transfer Fee:
  • Fee Percentage: 2.99%
  • Transfer Fee: £3,200 x 0.0299 = £95.68

Total Amount Transferred

• Total Transferred Amount:
  • Original Debt: £3,200
  • Transfer Fee: £95.68
  • Total Amount on New Card: £3,295.68

Interest Saved Over 22 Months

To calculate the interest saved, we need to determine the interest that would have been paid if John stayed on the original card with a 29% APR.

1. Monthly Interest Rate on Old Card:
   • APR: 29%
   • Monthly Interest Rate: 29% / 12 = 2.42%
2. Interest Calculation for 22 Months:

• Using the formula for simple interest for illustrative purposes:
  • Interest per Month: £3,200 x 0.0242 = £77.44
  • Total Interest Over 22 Months: £77.44 x 22 = £1,703.68

This is a simplified calculation; actual interest may vary due to compounding and payments made during the period.

Total Savings

• Interest Saved:
  • £1,703.68 (interest on the old card)
• Minus Balance Transfer Fee:
  • £1,703.68 – £95.68 = £1,608.00

Summary of Savings

• Original Debt: £3,200
• Transfer Fee: £95.68
• Total New Debt: £3,295.68
• Interest Saved Over 22 Months: £1,608.00

By transferring the balance to a new card with a 0% introductory APR for 22 months, John saves approximately £1,608.00 in interest payments, even after accounting for the balance transfer fee. This move significantly reduces his debt repayment burden and provides a clear financial benefit.