A balance transfer is a financial transaction in which an owing balance is shifted or “transferred” from one credit card to another. In other words, one credit card is essentially used to pay off another. Cardholders most commonly use balance transfers as a way to save money on interest.
For example, let’s say you have two credit cards with different interest rates:
1) A card with 24% variable APR
This card has a limit of $10,000 and a balance of $3,000.
2) A card with 10% variable APR
This card also has a limit of $10,000 and a balance of $1,000.
While you could certainly continue to pay 24% interest on a balance of $3,000, you also have the option of saving money by transferring that balance to the card with the lower interest rate. This would pay off the card with 24% APR and leave the 10% APR card with a total balance of $4,000.
After reading the scenario above, you might be asking why someone would keep making purchases on a high-interest card. After all, wouldn’t it be easier to avoid a balance transfer by only using the lower-rate card in the first place? There could be a few reasons for this.
First, a card might have a high APR because it offers a rewards program. And if a card has good rewards, then people will continue to use it. In general, the more rewards a card offers, the higher its interest rate will be. Of course, a high rate might not be cause for concern if you’re able to avoid interest by paying off the balance each month. But if you have built up some debt on a rewards card (or any other high-rate card), you may choose to transfer the balance to a lower-rate card in order to save money on interest.
Another reason you might do a balance transfer is if your credit standing has improved. In this case, you might qualify for a new card with a better interest rate than your old one. Then, you can transfer the balance from your old card to the new one.
If done wisely, transferring your balance to a card with a lower rate can also help you pay off your debt quicker. This is because a lower APR will add less interest to your balance each month. In order for that to work, however, you may also have to adjust your spending habits. Be cautious not to let a lower interest rate encourage more spending than is needed.
A balance transfer is done by taking funds from one credit card and then using those funds to pay off all or some of the balance on another card. There are a few steps you’ll need to complete in order to transfer a balance.
You have two credit cards:
1) A card with 24% variable APR
This card has a limit of $10,000 and a balance of $3,000.
2) A card with 10% variable APR
This card also has a limit of $10,000 and a balance of $1,000.
You’d like to transfer the balance of $3,000 from the 24% card to the other. To do this, $3,000 will be taken from the card with 10% APR, making the total balance on that card $4,000. Next, the $3,000 that was taken from the 10% card will be used to pay off the 24% card. Your financial institution can do this a few different ways. For instance, they could simply make the $3,000 available in your savings account and let you transfer it to your higher-rate card online, or they could put the funds on a cashier's check and mail it to your other financial institution.
If you don’t have a low-rate card to transfer a balance to, you can consider applying for one. However, only take out another card after verifying that your credit and finances are in a good position to do so. Applying for too many credit cards may lead lenders to believe that you rely too much on credit, and you may be seen as an unreliable borrower.
Some financial institutions offer credit cards with an introductory rate of 0% APR to new cardholders. These are sometimes referred to as “balance transfer cards” because they encourage new members to transfer their balances over to their new cards. Balance transfer cards can be a great way to consolidate debt and pay off a balance while saving on interest. At the end of the day, it’s important to remember that they still function as regular credit cards. The 0% introductory rate will eventually expire, at which point interest will start to accrue on any balance that remains.
Another factor to consider is that most credit cards have variable APRs, meaning their interest rates can move up or down depending on the market. Keep in mind that your card’s APR could increase at some point after you’ve transferred a balance to it.