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A balance transfer seems to be a winner - a winning situation for both the loan applicant as well as for the lender. It allows the borrower to scout around for a better deal for his loan, and it helps the lender to add to its customer base quickly. Moreover, before we get into the pros and cons of a balance transfer, let us first understand what it is.
A balance transfer means that the borrower of a loan transfers the present outstanding on his loan from his present lender to a new lender, and along with it, the charge on any property or collateral that the present lender enjoys also gets transferred to the lender who takes over the loan. This is very frequently used in credit cards, personal, home, and business loans.
The minimum tenure of any credit is around one month in the case of credit cards, and could go up to fifteen or twenty years in case of a home loan. In the case of short duration credit, like in the case of a credit card, the reason why balance transfer is so attractive is that it allows the applicant to enjoy some amount of interest free period with the new lender. The applicant might also be able to convert the old outstanding amount into monthly instalments and repay the present dues in the usual way as per billing cycle. For longer duration loans like personal loans of 3 to 5 years, or home loans of 15 to 20 years, the fluctuations in the interest rate might present an opportunity to the borrower for arbitrage, because a couple of years after getting the loan. The present lender might charge the original rate of interest while a competitor might be willing to offer softer rates on account of depressed market conditions or lower interest regimes.
If everything about a balance transfer is so attractive, why does everyone not continue to transfer his balance again and again till the loan is finally paid? The reason is that everything is not as rosy as it looks.
First, many of us do not find out about or understand the fine print in a loan. A simple comparison of two interest rates apart, one must understand the structuring of the interest rate also. One should understand clearly the meaning and implications of teaser rates of interest (which are low for the first couple of years and are linked to federal rates subsequently), floating rates of interest (where the rate would be indexed to the federal rates) and fixed rate of interest (where the interest rate is fixed for the whole tenure).
Second, frequent balance transfers might make future lenders wary of you, and could even impact your credit score negatively, so one should not overdo it.
Finally, such transfers also involve paying a fee to both the old as well as the new lender, so you must factor those amounts into your calculations as well.
If you can look into all possible factors and possibilities before taking the plunge, a balance transfer can be a great help if used sparingly and judiciously.