Mortgage lenders may be tightening their credit standards, but based on the amount of mail I get, credit card companies aren't slowing down their efforts to gain new customers. One of card issuers' most popular enticements to sign up for new plastic involves offering low-interest balance transfers from other credit cards. You generally have several months to pay down your balance before the regular rate -- usually much higher -- kicks in.
A few years ago, when interest rates were extremely low, a lot of cards started offering 0% teaser rates on balance transfers. For instance, you could get 0% from the Citibank affiliate of Citigroup
Before you jump at the chance to cut the costs of your credit card debt, however, make sure you know exactly what you're getting into. These attractive deals include several traps for the unwary.
Big transaction fees
When balance transfers first became popular, several card companies happily performed them without any upfront costs. However, some enterprising customers found ways to game the system. Specifically, you could request a balance transfer from an old card, even if it didn't have a balance. The result would be a negative balance on your old card, which you could get paid to you by check, simply by calling up the card issuer. You could then take the money and either spend it or invest it, essentially collecting risk-free interest for a few months. Then, when the teaser period was about to end, you'd pay off the balance transfer, pocketing your income. On a $10,000 balance transfer, you could expect to earn a few hundred dollars.
In order to thwart this strategy, card companies started charging substantial transaction fees for balance transfers. Now, it's not unusual to pay as much as 3% on a balance transfer. If you transfer $10,000, you'll probably see a $300 finance charge on your first bill.
Those fees can sap much of the excitement from a seemingly sweet deal. On a 0% six-month offer, for instance, paying a 3% fee raises the effective annual interest rate to 6%. That might not be a bad deal for you -- but it's a lot more than all the "no interest" claims you'll find in those offers.
Avoiding the "gotcha"
You should also watch out for what's included in the low-rate promotion. For instance, many offers give you the low rate on balance transfers, but charge you higher rates for regular purchases. Then, when you make payments, the issuer applies them to the low-rate balance first. Since you can't pay down the high-rate charges until your low-rate balance transfer is completely paid down, the net effect is that you pay higher rates, even during the promotional period.
Similarly, after the low-rate promotional period ends, higher rates usually kick in. Clearly, issuers hope that those higher rates will make up for the low rates you enjoyed during those first few months. Your best strategy is to pay the balance off entirely if you can, but as an alternative, you can consider making another balance transfer to a new card. Many borrowers on our Credit Card discussion board have used this strategy to successfully eradicate their debt.
Be careful out there
You've often got to really work to unearth all the terms and conditions in the fine print of a seemingly attractive credit card offer. Even that information often points you to other sources not included with the offer. Furthermore, customer service representatives can't always answer questions about specific offers. Doing due diligence can be frustrating.
But that homework is the best way to avoid getting burned by these offers. Used properly, balance transfers can save you hundreds in finance charges. But if you fall into the credit card companies' traps, you could see those savings evaporate in a hurry.
You can get more information about how credit cards work in our Credit Center. You can learn how to get better rates, find the best card for you, and much more.
Fool contributor Dan Caplinger has given up on balance transfers for fun and profit. He doesn't own shares of the companies mentioned in this article. JPMorgan Chase is an Income Investor recommendation. The Fool's disclosure policy won't burn you.