Imagine that you have a credit card
where the annual percent rate is 20% and your outstanding balance is 500 hundred dollars. Supposing your credit limit is 1000 dollars, your balance is 50% of the limit. Now if you get a new offer from another credit card company which offers an interest rate of 10%, you might be tempted to pay off the debt on your old credit card, with the new card as you will have to pay less monthly interest now. This is called balance transfer. In other words, you are transferring your outstanding balance from one card to another card.
Advantages of Balance Transfer
The first and most obvious advantage of a balance transfer
is obviously the lesser amount of interest that you will have to pay after the balance transfer. There are many credit card companies that have differential terms for a balance transfer scenario, where they offer higher interest rate after the initial term period but usually very less or 0% interest rate on the outstanding balance during the initial term period. If that term period is 18 months, for example, and you have an outstanding balance of 500 hundred dollars, you have 18 months to repay that amount without incurring any extra interest, which will help your cause. It is like an interest free loan for that time period. Balance transfer can also be a good way of clearing up all the accounts where you have debts and cannot even keep track of. By doing a balance transfer, you can bring your outstanding debt to one account hence making it more manageable.
Problems with Balance Transfer
Not everything is rosy about balance transfers. If you take up balance transfer with a credit card that charges a higher interest rate after the initial period and fail to clear the due before the initial period, you might end up paying greater interest for the outstanding balance. If you close your old credit card, after balance transfer, you might end up hurting your credit score badly, because your new card doesn't have any history whatsoever and balance transfer of a debt itself negates your credit to some extent. You should be careful to see what the percentage of your debt in your credit limit is, summing the credit limit of the old and new card. You must ensure that the percentage is lower as that means a better credit score. Closing the card with greater credit limit will increase the debt percentage thus decreasing your credit score.
Hence we see that although balance transfer is one way of getting rid of your debts, it is not always the right way to improve bad credit. In fact, it can even worsen the credit history you have got. Hence, it is better to calculate your debt percentage, your monthly income and time to pay off your debts etc. instead of blindly going for a balance transfer and closing old accounts which is not advisable.