Pay off your debt interest-free -- some strings attached
The Fed may have lowered interest rates again, but don't expect your credit card debt to suddenly become affordable.
While you might see a small decrease in your credit card's APR as a consequence of the Fed lowering interest rates, the fact of the matter is that credit card debt is some of the most expensive debt you can carry. However, the CFPB report also shows that consumers are getting savvier when it comes to avoiding interest fees: from 2015 to 2018, the annual volume of balance transfers increased by roughly 38%. That's bigger than than the growth in balances and purchase volume.
What are balance transfers?
One of the best ways to pay off debt quickly and avoid high interest rates is to take advantage of the best balance transfer credit cards.
A balance transfer is the process of transferring your existing debt balances to a new account. Balance transfer credit cards offer low introductory APRs -- sometimes as low as 0% -- for a period of anywhere from three to 21 months. When the introductory period ends, you pay the ongoing APR on your remaining balance, which is often above 20%. Most of these cards charge balance transfer fees of 3% or 5% of the amount transferred.
Balance transfers can help you pay off debt interest free
Here's how a balance transfer can work in your favor. Let's say you have $10,000 of credit card debt on Credit Card A that you're paying off at the average interest rate of 20.3%. You're looking at two balance transfer credit cards. Credit Card B gives you 0% interest on balance transfers for the first 18 months with a 3% balance transfer fee, and Credit Card C gives you 0% interest on balance transfers for the first 15 months with no balance transfer fee.
You want to pay off your balance in full before the introductory period ends to avoid being charged the high ongoing APR. The table below explains how much you would have to pay each month to avoid paying any interest, what you'd pay in fees, and how much you'd end up paying without the balance transfer.
|Credit Card||Balance transfer fee||Monthly payment||Time to pay off balance||Total amount paid|
|Credit Card A||N/A||$573||21 Months||$11,951|
|Credit Card B||$300||$573||18 Months||$10,300|
|Credit Card A||N/A||$667||18 Months||$11,632|
|Credit Card C||$0||$667||15 Months||$10,000|
Data source: Author's calculations.
As you can see, doing a balance transfer and paying off the balance during the introductory period could save you up to almost $2,000 on interest.
If you took Credit Card B, you would be looking at a monthly payment of $573 and would have paid off your debt in 18 months. Credit Card C would save you the most money and get you debt-free faster, but you would need to make a monthly payment of $667.
When you're choosing between different balance transfer credit cards, you want to minimize the fees you pay. This can mean going for a card with no balance transfer fee, but these cards typically have shorter introductory periods, so you can expect higher monthly payments. If you can't afford those, it can make sense to choose a credit card with a 3% balance transfer fee and a longer introductory period. Either way, you're likely to save a significant amount of money.
The pitfalls of balance transfers
It's important to know that balance transfers aren't always a good idea.
One of the biggest drawbacks of balance transfer offers is they're typically only available to people with good credit. According to the CFPB report, the growth in balance transfers in recent years is happening almost exclusively amongst consumers with prime and superprime credit scores -- that is, consumers with credit scores of 660 or above.
Near-prime consumers -- or those with scores of 620 to 659 -- will find it very difficult, though not impossible, to qualify for a balance transfer credit card. If your credit score falls below 620, you'll probably have to work on improving it before you can take advantage of balance transfer offers.
Qualifying isn't the only hurdle to overcome. Even if you're approved for the credit card of your choice, you might not get the credit limit necessary to transfer over your full balance. If you're $10,000 deep in credit card debt, and you're only approved for a $5,000 credit limit, you'll only be able to transfer around half of your credit card debt. That being said, you're still saving money on interest fees.
If you do a balance transfer, you need to make sure you always make on-time payments, and that you pay off your balance in full before the introductory period ends. Missing even one payment could cause you to lose the introductory APR and leave you stuck with an even higher interest rate than what you had before. Likewise, if you fail to pay off your balance on time, you'll end up paying the high ongoing APR.
Whatever you do, avoid the worst pitfall of all: Paying off debt on one credit card only to rack up a new balance. Leave your credit cards at home, lest you be tempted to overspend again.
Balance transfers aren't a one-size-fits-all solution. However, for folks who can qualify for a good balance transfer offer, make on-time payments, and pay off their balance during the introductory period, balance transfers are one of the best ways to attack credit card debt.
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