The process of transferring the total amount owing on a credit card to another revolving debt instrument are known as balance transfers. This process allows cardholders to take advantage of a competitor's offering of a lower interest rate. Balance transfers are available from all credit card issuers and are a commonly used method of moving multiple credit card balances onto one credit card.
When credit card debt is moved to a longer term debt instrument, such as a line of credit or personal loan, it is called a debt consolidation. Multiple credit cards and other debts are combined into one debt, usually with a lower interest rate and a fixed monthly payment and term.
Interest charges on credit cards are calculated using compounding interest. The interest is calculated monthly, using the balance outstanding from the previous month and multiplying this amount by the interest rate provided in the credit card agreement. The interest value is added to the amount owed.
The next month, the interest is calculated again, using the new balance, which has increased with the interest amount. Compounding interest means that you are paying interest on the interest. By moving the balance from one card to another card with a lower interest your monthly minimum payment is less and the amount of interest paid for each period is less.
For example, if you have a $10,000 US Dollars (USD) balance on your credit card and are paying 10% interest, the monthly interest added to your credit card is $81.90 USD. If the interest rate was 5%, the interest is $42.16 USD. Over a 6 month period, you would save $252.96 USD in interest fees.
There are two critical details that you must be aware of with balance transfers; introductory or promotional interest rates and credit management. Take the time to read the new credit card agreement carefully. Look for anything that mentions "promotion" or "introductory." A lower interest rate is usually an introductory rate, and valid for a limited period, from 3 to 6 months. After this period, the interest rate increases, check what this rate will be and compare to your current rate.
Balance transfers to a lower interest card are a good way to make a deeper impact on your debt, but only if you are able to make significant payments within the introductory period. In order to take advantage of the lower rate, the entire balance must be paid off in the last month of the promotion and the balance for the next period paid off in full as well.
If you transfer the balance owed on a credit card to another credit card with a lower interest rate, cancel the first card. The temptation is to use that card and get deeper into debt. Now you have two cards, with two sets of minimum payments, neither payment is making any significant dent in the your total debt.
The only way to get ahead when using balance transfers as a debt management tool is to apply a great deal of discipline to your spending and repayment plan. Arrange your balance transfers by contacting the credit card that you wish to move the balances over to and discuss their process. Make sure this is not considered a cash advance, as the interest rate is much higher and compounded daily instead of monthly. Ask about any fees associated with this request and when it will be processed.
Provide them with the total amount owing and the credit card number. With this information, the lower interest rate credit card issues a payment to the old credit card for the total amount outstanding, thus completing a balance transfer.