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Research: Understanding balance transfers and how they work -

Balance transfers are considered to be the greatest marketing gimmick the credit card industry has ever come up with. However, we must fall short of calling it a gimmick. It is not only a marketing ploy; it is also a very good financial instrument for individuals knee deep in financial debt.

It is true that balance transfers help credit card companies add more customers to their customer base, but is also true that if it is used diligently by the customer, it can rid him or her of all his financial worries.

How does balance transfer actually work?

A balance transfer credit card is essentially a zero percent credit card. You will pay a certain fee to make a transfer of your outstanding balance from your current credit card onto a new credit card. The current credit card may be charging you a huge interest rate of almost 20% on the outstanding balance. The new credit card will have zero percent interest for an introductory period. If you manage to pay off the debt by this period, you will not have to pay any interest at all on the borrowed money. The only charges applied would be the balance transfer fee and the annual fee. This is where you need to be careful.

The balance transfer fee will usually be around 10% of the outstanding amount. Sometimes it will be a flat rate applied on the transfer. The annual fee will almost always be applied, as it is a zero percent rate credit card. You need to calculate and find out how much savings you are going to make on a balance transfer card.

For example, if you have an outstanding balance of $5000 on your current credit card, and they are charging you 20% as interest rate, then you will pay $1000 every year in interest. If you were to go for a balance transfer, you will pay around $500 on the transfer and if you pay off the debt by the end of the year, you will not incur any other expense. Hence, it is important to compare various credit cards to find out which ones will give you the best deal.

Apart from all this, you need to remember that a balance transfer can affect your credit score. Each time you apply for a balance transfer credit card, you are essentially applying for a new credit card. A new credit card application will bring down your credit score because the company will contact the credit bureaus for your credit report. Your credit score will suffer if a credit card company rejects your application. It is very important that you use the balance transfer option very diligently, and do not take it for granted as just another escape route to avoid paying your dues. Remember, after the grace period, you will have to start paying the regular interest rate on the outstanding amount.