What is a Balance Transfer and is it Good for Your Credit?

Credit card balance transfers are not a simple issue and it's important to understand as much as you can about what it is and how it works. A balance transfer can end up saving you hundreds or even thousands of dollars in interest if you use it properly.

Understanding Balance Transfers

The simplest definition of a balance transfer is that it is the transfer of the outstanding balance on one credit card account to another.

That sounds easy enough, but knowing what balance to transfer to which card is the really important thing to keep in mind. And to determine this, you have to know how and when your balance is calculated and how a transfer can impact your credit in general. You also need to make sure you have all the terms of every credit card involved, to get the most out of a balance transfer.

Calculating the Balance

Your balance is more than your principal. It's your principal plus any interest that has accrued over the billing period. This means your balance changes from day to day and is at its lowest at the beginning of the month, barring any payments you have made. The longer your balance is allowed to build up interest, the higher it becomes, as interest is usually added on a daily basis. Knowing how to calculate your interest involves the rate of interest as well as how it is calculated since that determines the percentage of your balance that is figured as interest.

For example, the APR is a set interest rate that applies daily. So, if your daily interest is figured at .05 percent, you can multiply it to your principal any day to find out what your balance is, as long as you multiply it for each day in that billing period. Average daily balance interest changes the interest owed, but not the interest rate. To determine your interest in these types of cases, you have to be able to determine your average daily balance and multiply it by the interest rate.

Why Transfer Balances?

You might only have $10,000 worth of credit card debt, but have that debt spread over 10 different cards and pay $100 each month on each card. If you have to make a large number of payments, it can be difficult to ever pay anything beyond the minimum payment, so your balance might seem to never go down.  When you transfer balances, that's one less payment you have to make, even if it means your payment increases. It isn't likely to be as much as you were paying out as separate payments, so you still have more cash on hand and you can pay the balances down faster. On top of that, if you happen to be late on your payment toward those balances, you'll have one late fee instead of two.

Further, many cards offer 0% intro APR periods for balance transfers when you sign up for the card. These promotions allow you to transfer a balance from another card, preferably one with a high APR, to a card with a 0% APR for a limited time. The introductory period can range from 6 months to 24 months, which gives you time to pay down your balance and eliminate debt without accruing or paying interest. You can read more about the best balance transfer cards here.

Deciding Which Balance to Transfer

The hardest part of transferring balances is deciding which ones to transfer when you have the opportunity. Many people would just assume you want everything on the account with the lowest interest rates, but this isn’t always the best method for determining which balance to transfer.

One of the biggest things that you need to consider when it comes to your credit report is how much credit you have as opposed to how much credit you use.

You really want to keep your balances below 25 percent if at all possible.

 So, if you have $20,000 in available credit and you are looking to close an account or two, you need to choose wisely.

When you close an account, this also removes the available credit from that account, which can result in a higher utilization ratio. For example, if you have $20,000 in available credit and you close out an account that has a $10,000 credit line, you just lost $10,000 in available credit. If you owe $5,000, you just went from using 25 percent of your available credit to using 50 percent of your available credit. You may have reduced your interest rate, but you're also using far more of your available credit than you should be.

One option is to transfer the balance, but not close the account completely, if that's possible. This also allows you to keep older accounts, which are rated as more important when it comes to your credit rating. Another option is to figure out which cards will result in the lowest percentage of your credit being used. Obviously, you will want your balances on the card with the highest credit limit, but you also have to figure out the interest to see if a transfer is really worth it.

If you have one card with a $10,000 limit and a 21% interest rate, and one card with a $500 limit and low 14% interest rate, it may not be worth transferring a $100 balance from the $500 credit card if you can help it. Also, keep in mind that there are often balance transfer fees of as much as 5 percent of the balance you are transferring. Make sure you have calculated exactly how much the balance transfer is going to cost you.

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You may be tempted to apply for a new credit card just to transfer your balance. And it may be worth it for you to do so, depending on your situation. If you have maxed out your credit, there is a good chance you won't get approved for the card. If that's the case, then a hard inquiry onto your credit report can do you more harm than good, as each one can potentially result in a decrease of a couple of points. Instead, pay your balances down so that you are using less of your available credit before you apply for more.

Looking for the best balance transfer offers is just the beginning. You need to be able to realistically compare amounts owed, interest rates, the total you can afford to pay each month, and how much the balance transfer will cost or save you. It’s important to keep in mind that your credit report tracks not only the amount of credit you use as compared to what's available, but also whether or not you are meeting your minimum monthly payments. Many lenders have limits regarding several of these points and you may not qualify even if you are making timely payments. You might also have to move accounts around so that you're only using a portion of the credit available to you, even if the total owed doesn't change. Remember, you want to use less than 25 percent of your available credit per open account, not per your total credit limit. 

Christina Majaski More than 10 years experience covering credit cards and personal finance

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