The Dangers of Balance Transfers

November 17, 2021 Erin Kann

What You Should Know Before Signing Up For That New Credit Card 

The lure of paying off debts more quickly by transferring balances from high-interest credit cards to lower-interest cards may seem like a no-brainer to many Canadians, but balance transfers can be a risky move if you’re not careful. So before you accept that promotional offer from your bank or a new credit card company, here’s what you should know about balance transfers.

What is a balance transfer?

A balance transfer moves the balance from one or more credit cards with a high interest rate to one with a lower interest rate. This tactic can be a way to consolidate credit card debt, save on interest, and potentially use those savings to pay off your debt faster.

How can it be used?

If your current credit card has a high interest rate, moving that balance to a new card with a lower annual percentage rate (APR) can instantly reduce your monthly minimum payments and help you pay less in interest during the introductory rate period. You can then use these savings to pay off your balance faster, or even build up an emergency fund. But be aware that, even with a new, lower rate,  the actual amount of interest you’ll pay can be affected by how often that interest is calculated (known as “frequency of compounding”).

If you’re having trouble keeping up with your existing debt payments, a balance transfer can also help you temporarily avoid the steep late fees and other penalties associated with missed or late credit card payments.  

What are the upsides?

Low-interest balance transfer credit cards will often offer a promotional APR on balance transfers, sometimes as low as 0%. During this initial period, which might last for 6 to 18 months, you are able to save money by paying little to no interest on your credit card balance. 

Balance transfers can also be helpful as a debt-consolidation tool, especially if you have balances on multiple credit cards with different interest rates and monthly payment schedules, and you want to keep better track of your finances.

What are the hidden risks?

Keep in mind that you may have to pay a one-time balance transfer fee, often a percentage of the total amount, to move your balance to a new credit card. And be sure to read the fine print on any agreement—the ultra-low rate on your new card may apply only to balance transfers and not new purchases.

One of the less hidden risks with any sort of revolving credit product like a credit card is that there may not be a clear path to paying off your debts.  For example, you might be tempted to spend more on the card, or to make lower payments, extending the term and paying more interest and adding more debt as a result. . Just remember that when the promotional period is over, you may be facing the same high interest rate that you have right now, or potentially one that is even higher. Ideally, you want to try to pay off as much of the principal balance amount as possible during the introductory period; otherwise, you’re simply shifting the amounts owing and interest paid to a later date.

How can you make the right decision for you? 

The net benefit of a balance transfer depends on the interest rate of your current credit card(s), the specific promotional APR and introductory rate period that you’ve been offered, and any balance transfer fees that may apply.

Our Debt Consolidation Calculator can help you figure out if a balance transfer makes sense for you—and whether it’s even worth the hassle. In just a few minutes, the calculator can show you the potential savings on interest payment for your personal scenario.

What are some other options?

If you're serious about paying off your debts more quickly and getting off the the credit-card carousel, a more structured approach, such as debt consolidation, offers the benefit of certainty. Put simply, debt consolidations is when you use a new loan to round up and combine your existing smaller debts that are spinning out of control. And while it might not look as appetizing as a temporary low interest rate on a balance transfer, it offers some clear benefits. Not only does a consolidation loan reduce the risk of late payments, but it can help your reduce the overall amount of interest you're paying, ensuring that your debt disappears sooner. 

 

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