When you’ve finally decided to buckle down and get rid of your debts, one of the first pieces of advice you’ll find anywhere about how to approach the problem is to line up your debts by interest rate with the highest one first, then make minimum payments on all debts while putting a big extra payment toward that highest interest debt at the front of the line. When that debt is gone, you move on, putting your big extra payment each month toward the debt that’s now at the front of the line, and so on until the line is empty.
Of course, one way to make this debt lineup a little easier to tackle is to look for ways to reduce the interest rates on those debts before you line them up. You might do things like consolidating your student loans or refinancing your home, but another option that people often use is to sign up for a new credit card with a 0% balance transfer offer.
How do balance transfer offers work?
When you sign up for a card with a 0% balance transfer offer, you can agree to immediately put a balance on that new card. The credit card issuer will then directly send a payment for that amount to the company behind your old credit card, usually paying it off or paying off a large portion of it.
So, let’s say you have $1,000 on a credit card that charges 29.9% interest. You sign up for a new card with a 0% balance transfer offer, and take that offer. Your new card starts off with a $1,000 balance on it, and then that company sends a $1,000 payment to your old card, paying it off.
The fresh balance on your new card is special – it’s almost treated like a separate balance on the same card because it has a few particular rules applied to it.
First of all, that transferred balance will have an interest rate of 0% applied to it for some number of months, usually 12 or 18 depending on the offer. For that time, no interest will be applied to your account.
There’s a catch, though: the company will still calculate the interest that would have accumulated on that amount, and it’s often a higher rate than normal. They’re not applying it to your account yet, but they’re keeping track of it.
Why would they do that? For most 0% balance transfer offers, if you reach the end of the period where the 0% offer applies and haven’t paid it completely off, they’ll apply all of that calculated interest to your account.
So, let’s look at that $1,000 example again. Let’s say the balance transfer offer lasted for 12 months and the “hidden” rate was 36.9% APY. At the end of that year, if you haven’t paid off that entire $1,000 balance, then $369 will be added to your credit card bill. Even if you just have $50 left to pay off, you’ll still owe all of the interest that would have accumulated.
You will have to read the fine print to find the “hidden” interest rate on your balance transfer. They’re obviously going to broadcast the 0% balance transfer rate and hide the much higher rate you have to deal with if you don’t pay off the transfer in time. Look for it – it’s important.
So, why do you want a 0% balance transfer offer at all? It’s because, if you pay it off before the offer expires, you’ll save a lot of money.
If you left that $1,000 on your old card at 29.9% interest and aimed to pay it off over the course of a year with 12 equal payments, you’d have to pay $97 a month, or a total of $1,164, to pay it off.
If you transfer that $1,000 over to a 0% balance transfer offer and pay it off over the course of a year with equal payments, you’d have to only pay $84 a month, a total of $1,000. It saves you $164 if you make all the payments.
Of course, these numbers refer to a balance of $1,000. If you transfer a large balance, everything multiplies! In the example above, transferring a $5,000 balance would actually save you $820.
Of course, if you don’t pay it all the way off, you’d actually owe more interest in this example than if you’d just left it alone, and that’s true for many balance transfer offers.
So, the key to getting the most value out of a balance transfer offer is to pay off the whole thing before the balance transfer offer runs out. If you do that, you’ll save a lot. If you don’t, it may actually cost you a little.
Let’s talk about some strategies for doing that, while avoiding some common pitfalls.
Don’t move the debt with the 0% balance transfer offer down your list; rather, rank it according to the “penalty” rate.
When you execute a 0% balance transfer offer, it might be tempting to move that debt to the back of the stack. After all, it’s 0% interest, right?
Don’t do that. Instead, rank the card with the 0% balance transfer offer based on the interest rate you’d be charged on the transfer if you let it expire without paying it off. This is usually different – and higher – than the main credit card interest rate.
Why rank it so high if it’s at 0%? It’s simple – if you don’t get it paid off by the end of that transfer, it will be as if that balance had that higher interest rate all along.
I like to actually look at it a different way. I think of 0% balance transfer offers as being a nice “bonus” if I pay off this card quickly. If I transferred over $1,000, as in the example above, I think of it as actually accumulating the $369 over the course of a year, but if I pay it off, the credit card company is covering that last $369 for me. If I don’t, then they’re not going to cover it for me.
In other words, I don’t look at it as a 0% interest rate, but as a 36.9% interest rate with a really sweet bonus if I pay it off quickly, that bonus being that they’ll cover all of the accumulated interest.
That’s how I recommend that you treat it. Use the special interest rate for the balance transfer that you would be charged if you didn’t pay it off in time in order to prioritize your balance transfer amongst all of your debts. This will probably move it to the top of the stack, but that’s actually where it should be. If you pay it off in time, having it at the top of the stack will have saved you a lot of money versus putting it at the bottom and not paying it off in time.
Don’t use the balance transfer card for anything unless you’re extremely confident that you’ll have a $0 balance on that card very soon.
Rather than using your new card for purchases, wait for a while and make sure that you have paid off the balance transfer in full before using it for purchases. Instead, continue to use your old card (if you’re still using a credit card), which should now be balance free (or at least a lot lower in balance).
Why do this? It’s simple: if you use the new card, you add additional balance to the card. When you submit a payment on that card, most credit card companies will not apply that payment to the balance transfer amount. They will usually pay off the new charges in their entirety before tackling the balance transfer amount.
Thus, the only way you’ll be able to get that balance transfer amount down to $0 is to get the entire balance of that card down to $0. Adding additional charges to the card makes that harder, and if you wind up falling short, all of the accumulated interest from the balance transfer portion will pop up on the card.
(It’s worth noting that I am assuming that the old card you have has a lower interest rate than the “hidden” interest rate on the balance transfer on your new card.)
The best solution, of course, is to switch to using your debit card for most card purchases. That way, you avoid putting charges on any credit card at all and you’re forced to keep your purchasing well in hand due to the limits of your checking account.
Aim to pay it off before the offer expires, preferably with a few months to spare.
Let’s be clear: if you do not believe you can pay off your full balance transfer well in advance of the date in which it would expire, you shouldn’t do the balance transfer.
In fact, you should be on pace to do this. You should be aiming to pay off the entire balance transfer and reduce the total balance on that card to $0 well in advance of the end of the balance transfer offer.
Why is this so important? If you have a plan that gets things paid off with some breathing room to spare, you’ll still be fine if a few unexpected events happen along the way. Maybe your car breaks down halfway through the payoff period and you can’t make a big payment one month. Having some breathing room in your plan makes that tolerable.
This doesn’t mean you should slow down at the end. Pay it off before the end of the 0% balance transfer period, then move onto the next debt. That way, you can be dead certain it’s paid off.
There’s another reason to pay it off early: it gives you time to handle things that might go wrong at the last minute, which I’ll discuss below.
Make absolutely sure your last payment went through, again with plenty of time to spare.
Look at a 0% balance transfer offer from the eyes of the credit card company. If you pay it all off on time, then they’re not making any money from giving you that offer – in fact, it cost them money. Their best outcome is that you don’t get it paid off in time – that you fail to cross your t’s and dot your i’s and then they can slap all of that extra interest right on your account.
That’s why you want to check and double-check and triple-check that, after you made the last payment on that balance transfer debt, the whole thing is paid off in full.
You want to make sure that balance is $0. You want to make sure you submitted the right amount. You want to make sure it was submitted in plenty of time. You want to make sure there weren’t any extra fees on that account.
You also want to give yourself enough time to fix those things if they do pop up. This is another reason why it’s a good idea to just get it paid off a month or two before the end of the balance transfer offer. That way, if something isn’t quite right, you have enough time to fix things up before the clock runs out.
So, is a 0% balance transfer really worth it?
It is, but only if a few things are true.
One, you have to have the capacity to pay off the entirety of that balance transfer well before the cutoff date of the 0% interest rate offer. If that is even remotely in question, then you shouldn’t take the offer.
Two, you have to be committed to a consistent plan to pay off that balance transfer. Knowing that you can do it isn’t enough. You need to have a plan for doing it. For example, if the balance transfer lasts a year, you should aim to make 10 equal payments, each equal to 10% of the balance transfer, at minimum. Ideally, you’re making even larger payments than that. So, in the example above, if you’re transferring $1,000 and the offer ends in a year, aim to make 10 payments of $100 over each of the next 10 months at minimum and try to make even bigger ones if you can.
Three, you have to be a stickler for details at the end. You need to be willing to log into the account in advance of the end of the offer and check to make sure the balance is $0 and the whole thing is paid off. Don’t just trust the “minimum payment” on your statement. Check and make sure that your current balance is $0, and do it with enough time that you can fix it before the clock runs out. This is important, or you’re going to get dinged hard.
I also highly suggest not using the new card for anything until you’ve reached a $0 balance and it’s stayed the for a while, just to make sure any “surprises” don’t pop up. Instead, if you’re going to continue to use a card, either use your debit card and just rely on what’s in your checking account or continue to use your old credit card.
If you follow these steps, then you will find that a 0% balance transfer offer can save you a lot of money.
What should you do if a 0% balance transfer offer isn’t right for you?
If you considered the factors above and decided that a 0% balance transfer offer isn’t right for you, what should you do?
First of all, assess whether you can switch to just using your debit card and cash for purchases going forward. If you’re in a situation where you’re serious about getting rid of debt, then you should absolutely be able to live without your credit card. You can use your debit card and cash for in-person purchases and your debit card for online purchases.
If you can handle things without that credit card, call the issuer of your old credit card and negotiate your rate. You will have the most success with this if you consistently carry a balance but not one that pushes against your credit limit very often while also keeping up with payments (not just on this card, but with all of your bills). In the eyes of a credit card company, that makes for a good customer that they want to retain, so they’re going to be willing to work with you a little bit.
If you rarely carry a balance, often push up against your credit limit, and are consistently very late with payments, the credit card issuer isn’t going to see you as a good customer and won’t be interested in lowering your rate. In fact, there’s a chance they may just cancel the card. If this sounds like you, don’t bother calling them up.
If you do think you’re a good candidate for a rate reduction, call your credit card issuer and simply ask for a reduction in rate. Tell them the truth – you’re trying to improve your financial situation, and that you’re considering a 0% balance transfer to another card to help out, but you want to see if they will improve your interest rate first. If you’re in good standing, they’ll likely lower your rate somewhat, which will help substantially.
In either case, stick to your debt repayment plan. It works. Keep making minimum payments on all of your debts and make a big extra payment on the debt with the highest interest rate. Do that month in and month out without adding more debts to the pile and you’ll see nice progress.