If you have several debts from different loans and credit cards, consolidating them into one account can help you pay them off. By combining your account balances into one, the interest rate will likely be reduced, the payment schedules will merge into one monthly payment, and it will decrease your credit utilization ratio.
However, a balance transfer could also help you pay your debt but it will also have some adverse effects on you financially, especially on your credit score. So before deciding to do a balance transfer, first, you should know what it is and how it works.
What is a balance transfer?
- 1 What is a balance transfer?
- 2 Increase of credit utilization rate
- 3 Lowering of credit age
- 4 Hard inquiries in your credit report
- 5 How to do a balance transfer without hurting your credit score
- 6 Choose the right card
- 7 Do not maximize the credit limit of your balance transfer card
- 8 Avoid purchasing too much
- 9 Takeaway
In simple terms, a balance transfer is the process of transferring one or more debts from your credit lines into another card that has a much lower interest rate.
By doing this, your payments will go along the principal balance monthly instead of having to pay each credit line with individual interests. This comes with a price, though. Here are some of them.
Increase of credit utilization rate
Your credit utilization ratio, which is the amount you owe compared to the overall credit limit, makes up 30% of your credit score.
If you open a new credit line, your credit limit will increase, making your credit utilization ratio go down. However, if you do a balance transfer, the credit you utilized will increase. This will affect your credit score significantly.
For lenders, credit utilization is essential. Lenders like to see a low percentage of credit utilization since having a high rate means the client has a habit of overextending from the total credit limit and defaults.
However, you can rebound from this situation if you pay your debt as soon as possible. By keeping your balances below 30%, this will help your credit score improve, not to mention, having higher chances of approval when applying for loans.
Lowering of credit age
In calculating your credit score, the average age of all your credit lines and the age of your oldest account will be considered. For you to do a balance transfer, you need to open a new credit account. This will be bad for your credit score as opening a new credit line will lower your average credit age, which is 15% of your credit score.
Hard inquiries in your credit report
Opening a new credit account would not only lower your average credit age, but it will also put on a hard inquiry on your credit report. This is especially true if you open several accounts in a short amount of time and if you get rejected in your balance transfer personal loans. Balance transfer credit cards require a good to excellent credit score as a requirement for applying.
To be specific, having a credit score of 700 and higher will give you a higher chance of getting approved for a balance transfer. Ensure this first, and you will get approved, but if you fail to do so, you will get rejected. If you get rejected, this will put on another hard inquiry on your credit report, which will affect your credit score negatively.
How to do a balance transfer without hurting your credit score
Doing a balance transfer may affect your credit score negatively, but there are also ways to do so without worrying about your credit score in the process.
Choose the right card
Every balance card from issuers has a different borrowing limit. Of course, there is no way to know this, and applying for several balance transfer cards will make things worse. Even then, there are ways for you to know which card is the right one for you. You can compare the promotional features of each card, like how long do they offer a 0% in their APRs and the like.
Do not maximize the credit limit of your balance transfer card
If you manage to get approved for a balance transfer card, transferring your balances that will maximize its credit limit will make a negative impact on your credit score. Optimizing your credit limit will increase your credit utilization rate, which can more or less decrease your credit score points by up to 45.
Avoid purchasing too much
Purchasing things during the balance transfer period is a big no since it will just worsen your debt.
The repayments you’ll make will likely go to your purchase if the rate of your balance transfer rate is 0%. This means that the repayments you are making are being used to pay off the purchase instead of going to your debt.
If you consider all the factors mentioned above, the balance transfer will do right more than wrong. Your debt will be dealt with consistently and efficiently, all the while maintaining your credit score. Yes, you will lose some points if you open a new credit line to do a balance transfer, and not to mention this will affect your overall credit age. But if you pay your debt as fast as you can and paying them on time, you will regain those points that you lost while doing that balance transfer.
Raj Kumar is a qualified business/finance writer expert in investment, debt, credit cards, Passive income, financial updates. He advises in his blog finance clap.