Most cards now offer a balance transfer deal to entice customers to switch from other cards, but are they a good idea, or are the long term costs too great?
You might be surprised to learn how banks define the ideal consumer. It isn't the customer that pays their balance in full each month and never misses a repayment - the bank doesn't make much money from them. It's the customer with a large outstanding balance who makes only the minimum repayment each month and on whom the bank reaps the maximum in interest and fees.
So it isn't surprising that most cards now offer balance transfer deals to entice customers with a large outstanding balance.
But while balance transfer deals are clearly good for the bank, are they good for the consumer? Does the short-term interest rate come at a long term cost?
It really depends on the offer and, more importantly, on what the interest rate will revert to when the offer ends. You should always check what the interest rate will be once the offer ends and make sure you understand how long the offer lasts for - most are around three to six months but some offer the special rate for the lifetime of the balance transferred.
There are some traps to watch out for:
- Most cards have two interest rates - the purchase rate and the cash rate (which applies to cash advances and is usually around 19.99%). On some cards, the balance transfer reverts to the cash rate, not the purchase rate, once the balance transfer ends.
- Check what your new credit limit will be. Sometimes the bank will only approve a credit limit lower than the limit on your existing card and perhaps lower than the balance to be transferred. If so, you may end up paying fees and interest on two cards. In some cases, the full balance will transfer over and you'll be paying penalty fees each month for exceeding your credit limit.
- Make sure the balance transfer will occur immediately and there won't be any delays. In some circumstances, the new bank may take a few weeks to process the credit to the old card. During that period, you'll be paying interest on both cards.
- Will the balance transfer negate any interest free period offered on the card? On many cards, the interest free period (usually 44 to 55 days) is dependent upon the full payment of the entire outstanding balance each month. If you have a balance transferred, any new purchases you make on the card may begin accruing interest immediately.
You should be wary of any balance transfer offer which will revert to a higher interest rate than what you're currently paying. While the balance transfer may offer some short-term relief, eventually, the higher interest rate will negate the benefit.
For example, let's say you transfer your $3,000 balance from an existing card offering 17% interest to a card offering 19% interest, but with a balance transfer offer of 4% for six months.
On your old card, you'd be accruing around $42.50 interest per month. On your new card during the introductory period, you'll be paying only $10 interest per month. Once the introductory period expires, you'll be paying $47.50 in interest per month.
Over the introductory period, you'd be saving $32.50 a month from your old card - a total of $195 saved over the entire offer. But after the offer ends, you'll be paying $5 a month more. After three and a quarter years, the benefit of the balance transfer will be negated.
