Balance transfers are an excellent way to consolidate your debt and pay it off as quickly as possible. But, it does have positive and negative impacts on your credit score. Despite some minor negative impacts, balance transfers can immensely transform your credit score. Here’s how:
How does a balance transfer negatively affect your credit score?
A balance transfer can cause a dip in your FICO® credit score in the short run. When you apply for a balance transfer, lenders conduct a hard inquiry to determine if you’re a capable borrower. Hard inquiries remain on your credit report for about two years. Several hard inquiries show you’re seeking credit from too many sources, which could indicate you may not be a reliable borrower. This differs from a soft inquiry, which is when you check your credit or a lender is trying to pre-approve you. Soft inquiries don’t affect your credit score.
Balance transfers can also lower your credit score by reducing the average age of your accounts. If you have three cards with an average account age of 48 months, and you decide to open a balance transfer card as your fourth, the average age of your accounts would lower, which could drop your score.
This has a minimal impact on your credit score, but it’s still critical to be aware of. You should keep old, unused accounts open to maximize the average age of your accounts. But, if an old account has a high annual fee that you can’t afford, then it might be in your best interest to close it—weigh the pros and cons before closing the account.
Example scenario
Let’s say you have two credit cards:
- Card A: $10,000 credit limit, $5,000 balance (50% utilization rate)
- Card B: $5,000 credit limit, $0 balance (0% utilization rate)
You transfer the entire $5,000 balance from Card A to Card B to take advantage of a 0% introductory offer. After the transfer:
- Card A: $10,000 credit limit, $0 balance (0% utilization rate)
- Card B: $5,000 credit limit, $5,000 balance (100% utilization rate)
While your total utilization remains at 33% ($5,000 out of $15,000), your utilization rate on Card B jumps to 100%. High utilization on a single card can hurt your score. If Card B is newer than Card A, this could shorten your average account age, which further negatively impacts your credit score in the short term.
How does a balance transfer positively affect your credit score?
Despite some negative impacts, a balance transfer can help considerably raise your credit score. Balance transfers reduce your credit utilization rate, which is the percentage of available credit that you’re using.
Low utilization rates show that you’re not accumulating debt. Ideally, you want your credit utilization rate to be below 30%. For example, if you have multiple credit accounts and move the balances to a single account, your credit utilization rate shows as 0% on the old accounts. It’s crucial to take advantage of the 0% APR period so you can pay off your debt as soon as possible. This will then decrease your credit utilization rate over time.
Your credit utilization rate accounts for 30% of your FICO® Score, which is the score most used by lenders.
Example scenario
Let’s say you have three credit cards:
- Card A: $10,000 credit limit, $6,000 balance (60% utilization rate)
- Card B: $8,000 credit limit, $0 balance (0% utilization)
- Card C: $7,000 credit limit, $0 balance (0% utilization)
You transfer $3,000 from Card A to Card B and $3,000 to Card C. After the transfer:
- Card A: $10,000 credit limit, $0 balance (0% utilization rate)
- Card B: $8,000 credit limit, $3,000 balance (37.5% utilization rate)
- Card C: $7,000 credit limit, $3,000 balance (42.9% utilization rate)
Your overall credit utilization remains at 33%, but spreading the debt across multiple cards lowers individual utilization rates, which can improve your score. If the balance transfer reduces interest and helps you pay off the debt faster, maintaining on-time payments will also strengthen your score over time.
Pros & Cons of a Balance Transfer |
|
|---|---|
| Pros | Cons |
| You have no or low interest. | You typically pay a fee of 3% – 5% of the balance transferred. |
| You can pay off debt quicker. | Your low or no interest is temporary. |
| Your debt can be consolidated into one single payment if you have multiple credit cards. | You could end up with more debt if you’re not disciplined. |
What should I do after I apply for a balance transfer?
After applying for a balance transfer offer, avoid opening new credit card accounts or applying for more credit. Limit the number of hard inquiries on your credit report as much as you can, and only apply for loans unless they’re necessary. Every hard inquiry can slightly lower your score, and limiting inquires is important when managing your debt.
If you have high-interest debt:
Prioritize the transfer amount
Focus on transferring the debt with the highest interest rates first, even if you can’t transfer the full balance. This reduces the interest you’re paying, allowing you to allocate more toward reducing the principal.
Don’t make purchases with your new card
Resist the temptation to spend on your balance transfer card. The sole purpose of your card is to pay off high-interest debt, not accumulate more. When you add to that debt, it makes paying your balance during the 0% APR period more challenging. Create a budget to cut out unnecessary expenses and avoid accruing more debt.
Create a payment plan
Calculate how much you need to pay monthly to clear the balance during the 0% APR period. Use this number to set up auto payments from your checking account.
If you have low credit utilization
Maintain a low utilization rate
Transferring a balance can temporarily increase your utilization on the new card. To offset this, avoid maxing out the card. Instead aim to keep the new card’s utilization below 30% of its limit, even after the transfer.
Focus on payment history
Since your utilization is already low, your payment history becomes even more critical. Set up auto pay to ensure you never miss a due date. This boosts your credit even more—payment history accounts for a large portion of your FICO® Score. Choose a specific amount to transfer from your checking account to pay your bill. It should be enough to pay off your card within your 0% APR period.
If you’re consolidating multiple debts
Select the right credit limit
Choose a card with a high enough credit limit to accommodate all or most of your balances. This minimizes the total number of open accounts and simplifies repayment.
Pay attention to fees
Consolidating multiple debts can involve balance transfer fees (typically 3% – 5% of the transfer amount). Factor these fees into your repayment plan to ensure you can pay off the full balance within the 0% APR period.
Keep older accounts open
After consolidating, avoid closing your older credit cards. Closing them could reduce your credit history length, which can negatively impact your score.
General best practices for balance transfers
Stick to your budget
Whether you’re managing high-interest debt, low utilization, or multiple accounts, create a realistic budget to cut unnecessary expenses and avoid accruing new debt.
Avoid new purchases
Your balance transfer card is a tool for paying off debt—not a license to spend. Adding purchases to the card can complicate your repayment plan and increase the likelihood of paying higher interest.
Pay on time, every time
Payment history is the most significant factor in your credit score. Use auto pay to ensure you never miss a due date.
Key takeaways:
- Balance transfers can help reduce your interest payments but might initially lower your credit score.
- Balance transfers are a great tool for consolidating multiple debts into one easy payment.
- Avoid making purchases on your balance transfer credit card and ensure you’re making on-time payments to pay off the balance within the introductory period.
Balance transfers can do wonders for your credit score and overall personal finance, despite some drawbacks. When you use a balance transfer card responsibly, your credit score can grow in the long run. Check your spending habits, stick with your budget, and you’ll be debt-free in no time with a credit score on the rise.
