A few days ago I got one of those promotional letters in the mail from my credit card company. You know what I’m talking about: those low interest balance transfer incentives that seem pretty enticing if you’re in debt.
“Take advantage of your low 1.99% promotional annual interest rate. All balance transfers that you complete between now and April 23, 2013 will get this great rate.”
I always shred these types of letters, but I remember there was a time not too long ago where I actually did do a balance transfer of existing credit card debt onto another credit card.
It was 2006. I was a 24-year-old new graduate with a maxed out credit card. I knew my plan was to aggressively pay down my credit card debt, but I didn’t know how long it would take me. So I decided to do a balance transfer in order to lower my interest rate so that I could get out of debt sooner. At that point, I did most of my banking with TD, and I know that sometimes you can negotiate the interest rate down on TD credit cards, but I just decided to move the money onto a completely separate Visa with a promotional interest rate.
The credit card balance transfer ended up working in my favour because I didn’t take on any new debt, and I was able to stick to my plan and eliminate my high interest credit card debt in less than 5 months. But, I was really nervous about doing it because there are so many reasons to be cautious when it comes to credit cards.
How a balance transfer works
A balance transfer is essentially a marketing tool used by credit card companies to bring in more customers and more accounts. The credit card company will agree to move your existing high interest credit card debt to a new account with an attractive interest rate for a set period of time. This is extremely profitable for credit card companies because often times consumers can’t pay off their debt before the balance transfer promotional interest rate expires.
Once you have transferred your high interest debt onto your new credit card, you will have a certain period of time to pay off all of your debt before the promotional period expires and your interest rate dramatically increases.
Understand the costs and penalties
You should be aware that there is usually a transaction fee applied to each balance transfer you make. For example, when I opened up my MBNA credit card a few years ago, I noticed that they charged a transaction fee equal to one per cent of the balance transfer dollar amount. There are some cards that charge as much as five per cent! So if I had wanted to transfer $5,000 from another card onto my MBNA credit card, I would have been charged $50 for the transaction.
It is also crucial to make your monthly payments – both during and after the promotional period. Some cards will automatically increase the Annual Percentage Rate (APR) by five per cent if you are late more than once within 12 consecutive billing cycles. Ouch!
So please, read the fine print extremely carefully.
Create a repayment plan
The best way to take advantage of a balance transfer is to pay off your debt before the promotional period ends. Start by deciding what amount of debt you want to transfer, and then divide that amount by the number of months in the promotional period.
For example, I had $6,000 in credit card debt, and my teaser interest rate was going to last for eight months. So, I knew I had to make monthly payments of at least $750. It was an aggressive plan, but I was extremely determined to do it.
Related: How I got into debt … and out of it
I ended up eliminating all of my credit card debt in less than 5 months, and it was at that point I made a vow to never, ever carry a credit card balance again.
Stop relying on credit
In order for a balance transfer to work you have to stop relying on credit, because it’s obvious how this plan can go horribly wrong: if you can’t refrain from using your credit cards, you will end up with more debt once the promotional rate expires. And then you’re in trouble.
I think it’s important to note that you should only use a balance transfer promotion if you can control your spending on both the new, and the old card. The best thing to do is cut up both credit cards so you aren’t tempted to rack up the balance as you start to pay down your debt and free up credit.