What Are Balance Transfers? Are They Bad?
Know Your Credit Part 4: One of the most frustrating things that I encountered while trying to understand my credit score was attempting to piece together all the scattered information on the subject. It is impossible to go to one place and get all the information you need, caveats and side notes included. The confusion led me to some poor financial decisions. Being that I do not want you to face the same difficulties I will create a string of blog post, that if followed in order will give you a complete understanding of credit scores in snack sized bits. All so you can digest it without being overwhelmed. At the end you will be the expert and run me out of town.
It is always a good idea to start a conversation by laying out what it is that you are going to be talking about. If you are here to understand what balance transfers (BT’s) are and understand the advantages and disadvantages of using them I have excellent news: you just hit the jackpot.
Alright, so what are BT’s? A balance transfer is a type of loan given to you by your credit card. As far as I know, I am the only person defining BT as loans. It is not that everyone else is wrong. The reason why most people will define balance transfers as “transferring a balance with a high interest rate to credit card with a low interest rate” is because that is in fact what MOST people use them for. Hence, a BALANACE TRANSFER.
However, that is only part of the story. Credit cards send people checks that can be cashed in your bank account. These checks ones used will be considered BT’s. What you do with the money is YOUR choice. You could pay off a high interest debt. Or you can do whatever else you want with that cash. The credit companies do not require you to use it in any specific way. They only care that you pay them back.
Now that you got the definition we can get into some of the nitty gritty of BT’s. For the most part, if you are not using a BT under a good promotional offer it is a really bad idea to use them. BT’s normally come with upfront fees and ridiculously high interest rates. That’s unless your credit card company gives you a good PROMOTIONAL OFFER. Then a balance transfer can become a powerful and helped financial tool.
How you say? First your credit card can offer to lend you money for a small fee, usually 3 to 5 percent. The really good ones wouldn’t charge you a fee at all.
Secondly, a promotional offer can allow you to borrow money at a very low interest rate or the magical and always welcomed 0% APR. Third, the low interest rate will last you for months — 3, 6, 9, 12 or more! All in all, BT’s can be really useful when you are in debt, need to make a sudden major purchase, or need cash for any other reason.
Aside from the promotional benefits you also have the monthly credit card minimums. These payments tend to be a small fraction of your total balance. For example, your monthly minimum credit card payment can be $100 on a $10,000 balance. This can be especially helpful when you are low on cash and need time to get back on your feet.
Are there any downsides to BT’s? YES. Balance transfers do have a major catch: the promotional interest rate does not last forever and when it ends you will be stuck paying high interest rates unless you pay the entire remaining balance or transfer the balance somewhere else.
Another huge disadvantage to BT’s is how complicate payments become when you use the same credit card to make purchases. That is because credit cards differentiate purchases, BT’s, and cash advances. What they will do is take whatever payments you make and apply them to the charges with the lowest APR. In this case your lowest APR is applied to the BT. That means that you are stuck paying really high interest rates on any other purchases made on your credit card until you finish paying off your BT. Sounds complicated, yea I know, it can be. Therefore, it is best not use the same credit card you used for a BT to make new/regular purchases. Keep everything separate!
In my opinion the biggest disadvantage to BT’s is YOU. I’m sorry dude, I got to call you out. Just give me a second to explain. For the average person it can become really difficult to keep up with what is going on with their money. Tracking every dollar spent, sticking to the budget while also dealing with work, relationships and the world around them. Adding a BT to the plate can be really useful at first but a nightmare thereafter if you aren’t paying attention. That’s why it is important to know the terms of the BT. It is also incredibly important to have a plan in place to promptly pay off the BT or transfer the debt somewhere else. Otherwise you will be in trouble.
You must be self-critical and honest. If you know that you tend to be forgetful or miss important details BT’s might not be for you. Then again, they might be a chance for you to change. That’s up to you to decide but be honest with yourself.
Okay, how does this all connect to credit scores? For one, balance transfer offers are left to people with good credit scores. This is further proof that poor credit scores make it that much more difficult for you to live financially stable.
Moreover, it is important for use to acknowledge what most people do not consider on a day to day. Life can throw curve balls at you and your future can depend on your ability to respond to such events. What will happen to you if you lost your job? If you got sick for a prolonged amount of time. If you suffered an injury? What if your mom, child, wife, husband, or best friend became sick or incapacitated? What then?
Folks, the biggest reason why people go bankrupt in the USA is due to medical expenses, not the mismanaging of their money. Think about that. Illness or injury can destroy all the financial pillars you worked so hard to build.
A good credit score is the buffer you need. It might not solve all your problems but what it does is give you financial tools like BT’s. Or personal loans which can deposit money in your account the next day. (I chose BT’s as an example because if used right they tend to be more cost efficient than personal loans.) It all goes to the same idea, which is “quick and easy access to cash.” These financial resources can help you stay afloat until you are able to get back on your feet at little cost. Someone with a poor credit score will likely sink because they simply do not have the access to cash required to weather the storm.
