If you’re looking for a way to lower the interest rate on your credit card balances, a balance transfer could help. By using a balance transfer credit card, you can transfer a balance from one credit card to another. In the process, you could score a promotional interest rate that’s lower, sometimes as low as 0% APR, and substantial savings on interest costs. Adding a new line of credit could also improve your credit utilization rate, which could improve your credit score.
While balance transfers can be a wise debt consolidation and interest-savings strategy, opening new credit lines has the potential to negatively impact your score. Here’s how balance transfers work and the effects they could have on your credit score.
[Read: Best 0% APR Credit Cards.]
How a Balance Transfer Could Hurt Your Credit Score
You could see your credit score dip if you complete a balance transfer by opening a new credit card account. That’s because new accounts on your credit report impact multiple criteria that credit bureaus use to calculate your score.
Inquiries
While inquiries only account for a small percentage of your credit score, you could see a temporary drop of up to five points when opening a new account. Applying for credit results in a hard inquiry on your credit report, and multiple inquiries over a short period can add up to a larger hit.
Age of Accounts
With every new account you open, you’re lowering your average account age — a calculation credit bureaus use to show creditors the length of your credit history. Shortening your credit history could decrease your credit score.
Debt Management
When you free up available credit by moving a balance from one card to another, you may be tempted to use your newly available credit. Making new purchases on the old card can increase your credit utilization ratio, and missing payments because you can’t keep up with the new debt can also decrease your score.
The ways a balance transfer could hurt your credit score aren’t meant to scare you. Instead, they serve as a reminder that credit bureaus calculate your credit score based on several intertwining factors. As you consider transferring a balance, however, it’s essential to consider whether you can keep up with the new monthly payment — financially and logistically.
“No matter the card, it is imperative to keep up with on-time payments, as payment history is a significant factor in determining your credit score,” says Kim Chambers, credit card product manager at Georgia’s Own Credit Union.
[Read: Best Credit Cards for Fair Credit.]
How a Balance Transfer Could Help Your Credit Score
You won’t see your credit score improve just by moving a balance from one card to another. However, you could see your score increase for many of the same reasons a balance transfer could potentially hurt your score.
Credit Utilization
Opening a new line of credit can decrease your credit utilization ratio, a key factor used to calculate your credit score. Lower utilization ratios can lead to higher scores.
For instance, say you’re using $10,000 of your $30,000 available credit, totaling a 30% credit utilization ratio before your balance transfer. If you open a new balance transfer credit card with a $20,000 credit line, you’re now using $10,000 of $50,000 in available credit, lowering your credit utilization ratio to 20%.
Speedier Debt Payoff
Since many balance transfer credit cards come with attractive promotional APRs, you could pay off your credit card debt in a shorter time. If you have a promotional 0% APR on balance transfers and you don’t add other charges to the card, 100% of your payment will go toward the principal during the introductory period, lowering your balance faster and improving your credit utilization ratio. “A lower credit utilization ratio generally translates to a better credit score,” says Christina Roman, consumer education and advocacy manager at Experian.
Interest Savings
Grabbing a 0% APR, if only temporarily, could mean substantial cost savings, especially when credit cards currently have an average APR of 22.63%, according to the most recent Federal Reserve data. A balance transfer can help you take all the money you would have paid in interest and put it toward paying down your debt.
Not only will lower balances help your credit score, but you may be able to use those savings to shore up your emergency fund. Having cash on hand for emergencies can help you avoid taking on high-interest credit card debt in the future, keeping your credit and score in tip-top shape.
[Read: Best Low-Interest Credit Cards.]
Why Should You Do a Balance Transfer?
Balance transfers can make good financial sense in various circumstances that go beyond reducing your interest rate, though that might be a leading factor in your decision. Transferring a balance can help you manage not only your existing debt, but also other budget obligations. Chambers offers more than a few benefits to keep in mind if you’re considering a balance transfer.
— Consolidate and manage debt. Balance transfers can be an organizational tool for streamlining finances, whether you want to transfer balances from multiple cards to lower your interest rate or simply make fewer payments each month.
— Increase your financial flexibility. By using a promotional APR to lower your total monthly payment, balance transfers can free up money in your budget for other financial needs.
— Reduce high-interest debt. Promotional APRs on balance transfer credit cards can help you pay down debt faster since little to none of your payment goes toward interest.
— Boost your credit score. New lines of credit can help improve your credit utilization ratio — especially if you don’t keep using your available credit. A lower credit utilization ratio can bump up your credit score.
Is a Balance Transfer Worth It?
Now that you know how balance transfers can affect your credit score, it’s time to decide if doing one is worth it for what you want to accomplish. To help figure this out, Josh Miller, head of consumer acquisition, marketing and product development at KeyBank, suggests consumers ask two questions: Will a balance transfer help me get out of debt sooner? And will a balance transfer ultimately help me reduce the total interest paid on my original debt?
“If the answer isn’t yes to both of these questions, you should hit the brakes and weigh the pros and cons before acting on an offer,” Miller says.
If you know a balance transfer is the way to go, it’s important to do your homework. Take time to compare different cards to find the right balance of promotional APR, term length and balance transfer fee. Once you find the card that fits your needs, there’s only one more step to take: plan.
“To make a balance transfer truly worthwhile, you should have a clear plan to pay off the transferred balance within the promotional period and avoid accruing more debt,” says Roman. By doing those two things, you’ll be helping your credit score from multiple angles.
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Do Balance Transfers Hurt My Credit Score? originally appeared on usnews.com
