How Does a Balance Transfer Affect Your Credit Score? – Councilor Forbes
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A balance transfer is a debt consolidation strategy that can help you when trying to pay off credit card balances and other high interest debt. When you manage the process wisely, a new credit card with balance transfer has the potential to save you money by temporarily lowering your interest charges.
Still, there is another factor that you should keep in mind if you are considering using a balance transfer to consolidate outstanding credit card balances. You will want to consider how a balance transfer will affect your credit score.
Like most questions about credit scores, how a balance transfer will affect you can vary. But in many cases, a balance transfer can boost your credit score. A poorly managed balance transfer process, on the other hand, could come back to haunt you.
What is a balance transfer
The term balance transfer describes the process of transferring existing credit card debt or loans to another credit card account. Many people open a new credit card and transfer balances to it. But you may be able to make a balance transfer with a credit card you already have.
Balance transfer offers often offer lower annual percentage rates (APRs) for a limited time, sometimes for a year or more. For example, a credit card company might offer balance transfers to new cardholders with 0% APR for 18 months. A credit card issuer you already do business with might offer you the option of transferring balances at a special, time-limited rate.
When you take advantage of a 0% or low APR introductory balance transfer offer, you can potentially save quite a bit of money. Plus, since interest is either paused or reduced with many balance transfers, you may be able to reduce or pay off your debt faster.
When a balance transfer could improve your credit score
A balance transfer will not increase your credit score on its own. But it could lead to changes in the overall makeup of your credit report that could be of benefit to you. Below are two examples of how a balance transfer can lead to a higher credit score.
1. Less use of credit
Your credit utilization rate – the relationship between limits and your credit card balances – is an important factor when it comes to your credit score. If you open a new credit card account and transfer balances from other credit cards to it, one of the side effects could be a drop in the credit utilization rate.
For example, suppose you have two credit cards with the following balances and limits:
In the above scenario, your overall (or aggregate) credit utilization rate would be 50%. This is the percentage of your available credit card limits that you use. If you’re interested in math, here’s a look at the equation you can use to calculate credit usage.
- $ 5,000 (total credit card balances) ÷ $ 10,000 (total credit card limits) = 0.50 x 100 = 50% credit utilization rate
Now imagine you apply for a third credit card with a 0% balance transfer offer. You qualify for a credit card with a limit of $ 10,000 and transfer $ 5,000 of existing credit card debt to the new account.
With your new credit card account and balance transfer, your overall credit utilization rate would drop to 25%.
- $ 5,000 (total credit card balances) ÷ $ 20,000 (total credit card limits) = 0.25 x 100 = 25% credit utilization rate
In general, a 25% utilization rate is much better for your credit scores than a 50% utilization rate. Plus, as you pay off your credit card balance, your credit utilization rate should drop even more until you take on new debt. In this scenario, your credit score would have a good chance of improving thanks to your balance transfer.
2. Fewer accounts with balances
Another factor that influences your credit score is the number of accounts with balances that appear on your credit report. From a credit scoring standpoint, it’s better to have fewer accounts with balances than too many.
Transferring balances from multiple credit cards or loans and combining them into one account reduces the number of accounts with balances on your credit report. When this happens, your credit score may improve as a result.
When a balance transfer can hurt your credit score
If you use a balance transfer responsibly, it can be good for your credit score. However, in some situations, a balance transfer can result in a lower credit score instead of a higher score. Below are three examples.
1. New hard credit check
If you are applying for a new credit card with a balance transfer offer, the request itself may have a slight negative impact on your credit score. When a lender checks your credit report, a serious credit investigation takes place. A credit check means someone has accessed your credit, and a “hard” check has the potential to damage your credit score.
In the long run, credit checks tend to be much less important than other information on your credit report. So, when deciding whether or not to apply for a new balance transfer credit card, keep the following details in mind.
- Credit demands are a factor that only affects 10% of your credit score.
- Not all serious inquiries trigger a drop in your credit rating.
- After 12 months, serious requests no longer influence your credit score.
You want to be selective when applying for new credit. But as long as you don’t overdo it, you don’t have to worry about asking for financing, like credit cards with balance transfer, when it can be to your advantage.
2. Duration of changes in credit history
Your credit history is another category of credit report that makes up your credit score. With FICO scoring models, the length of your credit history determines 15% of your credit score.
Some of the factors that play a role here include:
- The age of your oldest account on your credit report
- Your most recent age counts on your credit report
- The average age of all accounts on your credit report
Older accounts are ideal when it comes to your credit score. Thus, adding a new credit card to your credit report may result in a small drop in your credit score.
Keep in mind, however, that your credit history has less influence on your credit score than other factors (like payment history and credit usage). As long as you keep your credit usage low and your payments on time, these more significant factors could offset any potential drop in your credit score that a drop in your credit age might cause.
3. Problems caused by more debt
A balance transfer will only work in your favor if you handle the process responsibly. If you open a new credit card account, move your debt into it, and continue to incur new credit card debt each month, you could create serious financial problems. This type of behavior could also hurt your credit score.
Rising credit card debt could make it difficult to keep track of your payments afterwards. And because 35% of your FICO® score comes from your payment history, late payments can cause significant damage to your credit score. Failure to pay by credit card can also have other consequences, such as late fees and even account closure.
If you continue to accumulate credit card debt, your level of credit usage may also start to rise again. Higher credit utilization rates are never positive in terms of credit scores.
When a balance transfer can be a good choice
Balance transfers aren’t for everyone, no matter how attractive the offering. However, a balance transfer card may work for you under the following circumstances.
- You find a balance transfer offer that can save you money. The purpose of a balance transfer is to consolidate your debt, save money, and pay off your high interest debt. So you’ll want to analyze the numbers, including balance transfer fees, to make sure that a balance transfer credit card offer makes financial sense before you apply.
- You have a debt elimination strategy. It is essential to use balance transfers in the right way. They should be tools to help you pay off your debt, not a temptation to dig deeper into the hole.
- Your credit rating is healthy enough to qualify for a new credit card with balance transfer. Most card issuers require that you have good to excellent credit if you want to qualify for a new credit card with balance transfer. However, some credit card companies have fair credit balance transfer offers that may be worth considering.
- The balance transfer card you are considering is not from the same bank. Most credit card issuers do not allow you to transfer debt from an existing credit card to a new one from the same issuer. That said, some allow you to receive money into your checking account, which you can then use to pay your bills as you see fit.
If you’re struggling with credit card debt, but a balance transfer doesn’t seem like the right solution, you may want to consider credit counseling or even bankruptcy options. Either of these moves can impact your credit score as well. But the worst thing you can do is ignore that you have a problem and default on your debt.