Last weekend, a bachelorette party I was attending took an odd turn. Instead of chattering about the impending nuptials and playing suggestive games, the women discussed their troubled finances. I listened to the angst as two schoolteachers bemoaned the stress of carrying close to six figures in debt while surviving on meager salaries. I quietly asked if either of them had consumer debt. "Yes," responded one. "And how's your credit score?" I continued. "It's good," she said. "Well, maybe you should consider a balance transfer."
My statement hung in the air for a few moments before I heard the typical response: "What's a balance transfer?"
Let's Talk Numbers
In simplest terms, a balance transfer mean moving your debt from Bank A to Bank B to take advantage of a reduced interest rate. So let's say "Katie" has $10,000 of credit card debt at a 20 percent interest rate with Chase (JPM). She has a good credit score of 700 and makes payments of $300 per month.
Katie is paying $3,600 a year, and $1,845 of that over the next 12 months is going to interest. Katie can take advantage of a balance transfer offer and move her debt to another bank –- let's say Citi (C). (A transfer like this has to happen between two banks, not two accounts at the same bank.)
%VIRTUAL-article-sponsoredlinks%To entice Katie, Citi would offer her a very low or no interest rate for a set period –- likely from 12 to 18 months. Citi would want her debt because credit card debt is highly lucrative -- as are credit card customers. The bank hopes that if she opens a new credit card account with it, she'll keep spending, pay later or do both. But even more, it hopes that she still has a balance to pay off at the end of the low-interest balance transfer period, which will then incur higher interest rates.
If Katie moves her debt to a card with zero percent interest, she will be able to apply all her payment each month toward her principal. According to MagnifyMoney's tool, with one balance transfer, Katie could save $3,675. With multiple balance transfers, she could put as much as $4,118 back in her pocket.
Overcome Your Fears
Even though balance transfers could put thousands of dollars back in American debtors' pockets, many people still refuse to use them, and these three concerns are what hold them back.
1. There Is an Extra Fee
Banks typically charge a one-time fee for a balance transfer, usually 3 percent to 4 percent of the total, applied when the transfer takes place, and added to the balance of your debt. But that's a small price to pay: Remember, if your bank is charging a 20 percent interest rate on your debt, you're paying 1.7 percent per month anyway. In Katie's example:
No balance transfer: She pays $4,718 in interest over 50 months until the debt is paid off
One balance transfer: She pays $1,043 in interest and fees over 37 months until the debt is paid off
Multiple balance transfers: She pays $600 in interest and fees over 36 months until the debt is paid off
Those lower "promotional" interest rates more than make up for the fees spent on transfers.
2. My Credit Score Will Go Down
Applying for a credit card results in a "hard inquiry" on your credit report, and each one of those causes a drop of three to five points in your credit score, according to Quizzle, a free credit score and report site. Maxine Sweet, Experian's vice president of public education, told The Huffington Post that recent hard inquiries "account for very few negative points in scoring models and are even less negative within a few months." If our fictional Katie embraced this fear of losing five points on her credit score, she'd be valuing each point at $943.60. Seems a little steep when she could recoup the points in a matter of months and save $4,718.
3. The New Bank Could Increase My Interest Rate at Any Time
An unfounded fear exists that banks can lure someone into a balance transfer, and then drastically increase the interest rate months later. The Credit Card Accountability Responsibility and Disclosure Act of 2009 prevents banks from engaging in such devious tactics. Once you agree to a balance transfer at a set interest rate and period, you're guaranteed the rate as long as you follow the rules. Banks can only cancel your promotional rate if you're 60 days late with payments.
Rules of a Balance Transfer
Don't miss payments -- ever.
Complete the transfer. You usually have 60 days to complete your transfer or you'll lose the promotional interest rate.
Don't spend on the card. Interest will immediately start accruing on the new purchases (unless there is a 0 percent purchase offer). But it is best if you just don't spend since your goal is to pay off debt.
Don't use the card at an ATM. Never use a credit card for an ATM cash advance, but especially don't do it with a balance transfer card.
Finding a Balance Transfer
To qualify for a balance transfer, you'll need a credit score of 680 or above. "Banks are looking for 'high-balance, low-risk' customers," according to Nick Clements, co-founder of financial products comparison site MagnifyMoney. "That means you have credit card debt -- probably less than $20,000. But you always pay on time, and you are likely paying the minimum due or just a bit more. And you have had credit for a while." MagnifyMoney offers a free balance transfer calculator for consumers carrying credit card debt. Users answer three simple questions:
If their credit score is bad, average, good or excellent.
The amount of debt.
How much they can afford to pay each month.
The calculator generates a list of balance transfer options customized to a user's debt situation. Each card also comes with a transparency score rating, so users can tell if the terms are simple or complex.
When You Shouldn't Take a Balance Transfer
A balance transfer can be a simple way to slash interest rates and amount of time it takes to pay off debt. But it isn't necessarily right for everyone. "If you can pay off your debt in six months or less, than it probably is not worth doing a balance transfer," said Clements.
What If You Have a Lower Credit Score?
Individuals who have substantial credit card debt and a credit score below 680 may not qualify for a balance transfer, but they can still reduce their interest rates by using a personal loan. Sites like Lending Club or Prosper will allow you to see if you're pre-qualified by using a soft inquiry on your credit score, which won't cause any drop in points.
If you have the golden ticket of a 680 credit score or higher, keep Clements' mantra in mind: "You should never pay high credit card interest rates."
Erin Lowry writes for DailyFinance on issues relating to millennials, money and personal finance. She is the blogger behind Broke Millennial, where her sarcastic sense of humor entertains and educates her peers. She is also the brand and content manager for MagnifyMoney.