For over 2 decades balance transfer products have been amongst the most popular credit cards in people’s wallets (and purses), and it’s easy to understand why. They are designed to help consumers save money by reducing the interest they pay from high standard APR’s to 0% interest, for a set period of time. Because of this, they are a key tool for people wanting to rebalance their finances, and having a good understanding of how balance transfer cards work can help consumers make considerable savings.
In the most general sense, balance transferring is simply the process of transferring a debt (a balance – in accounting terminology) from one credit card to another credit card account. Most credit cards offer their account holders the opportunity to do this, but when it’s done using an existing credit card (without a promotional offer) it is normally at the existing rate of interest (typically a double digit rate of interest).
However, since the 1990’s, credit card issuers have been offering balance transfers at 0% interest as an acquisition tool (that is, to acquire new customers). It is these 0% interest balance transfer offers that people are generally referring to when they speak of balance transfers, as they offer people the most gain (in terms of interest rate reduction) for transferring a balance.
Although commonly referred to as “0% interest balance transfer credit cards”, the term is misleading as they are not always free of costs. Most cards offering balance transfers require that the customer pays a balance transfer “fee” – typically around 2-3.5% - to facilitate the transfer between banks/building societies.
Balance transfer fees are not normally payable by customers at the time that they transfer. Instead the cost of the transfer is added to the balance which has been transferred. This is clearly preferable to many consumers, as it means that they do not need to find the money to pay the fees at the point they transfer. However, this does mean that interest is then payable on these fees if they are not paid by the end of the interest free balance transfer period.
Whether balance transfer fees actually offer a true reflection of the costs incurred by banks to transfer money is unlikely. Many banks now use Faster Payments to make these transfers, with transactions costing no more than £3.00. So a 3% transfer fee on £1000 is charged out by the issuer at £30.00, offers the banks a 900% mark up!
As the UK balance transfer market becomes increasing competitive, issuers have been developing new ways which enable them to react quickly to market movements from their competitors, without having to redesign entirely new products each time.
One of these methods is the ‘balance transfer fee refund’ which enables issuers to quickly reduce the fee charged to consumers for transferring a balance. They do this by charging the fee that they had originally planned for the card, and then credit the consumers accounts with a refund for a given amount at the later date (normally within a matter of days).
Although balance transfer fee refunds occur automatically there are some circumstances in which they are not applied and therefore issuers are compelled to state that terms and conditions apply. In reality these conditions are not unexpected. They include requirements that consumers are not in default, in the process of closing their account and that they have applied through specific sites and at specific times.
The way banks use 0% balance transfers to attract customers is that they offer a very attractive deal which caps customer interest at 0% for limited period. Once the introductory period is over the interest rates revert to the standard APR, which is typically much, much higher. It’s at this point, when interest rates are well into double digits, that credit card issuers start to make most of their profits.
Of course this assumes that customers reach the end of their balance transfer period having made all of their minimum payments on time. Unfortunately, many customers don’t manage to make their payments, meaning that they automatically forfeit the introductory which means their deal reverts back to the original APR which is usually higher (as well as paying transfer fees on).
The obvious advantage of balance transfer cards is that it enables cardholders to reduce the amount of interest they are paying on their credit card debt, by fixing it at 0% for a given period of time.
This interest free period also provides an ideal opportunity for people to reduce their debts. If cardholders intend to clear debt by the end of the 0% period, it’s important to calculate what the monthly repayment should be (click here for our balance transfer calculator). By setting up a repayment plan, the monthly payments will go directly towards reducing debt, rather than purchases or interest charges.
Another benefit of using balance transfer credit cards is that they can improve your credit score. By paying off debts, individuals can show that they are able to manage credit, demonstrating to other prospective lenders that they represent a ‘good risk’.
Although balance transfers can appear very attractive to cash strapped consumers, there are things that consumers should consider before getting, and whilst using, balance transfer products.
Although balance transfer cards will help build and improve a credit rating (if used well), people really need to have a reasonable credit score to be accepted for a balance transfer card. Consumers with a poor credit history due to missed payments or county court judgements are unlikely to be approved for the best balance transfers.
That does not necessarily mean that people have to have perfect credit score. Most credit card issuers now also offer ‘down sell’ products to people who do not meet all of the requirements to get the very best balance transfer deals.
Acquiring new customers is not an easy task for credit card issuers. The fact that competitor issuers all offer 0% balance transfer deals means that many consumers are prone to ‘churning’ (moving to another credit card issuers) to escape high interest rates. Therefore credit card issuers are eager to see if, with some changes to the terms and conditions/rates, they can accept applicants.
This is general referred to as “risk based pricing” and is entirely legal as the rates published in adverts for credit products are “Representative”. That means, these rates are what at least 51% of customers can expect to receive. However, that means that issuers are at liberty to offer other rates to up to 49% of applicants.
These are applicants, who the issuer might, under other circumstances, have had to refuse credit to. But, re-pricing them based on the additional risk that they represent to the issuer (due to prior missed payment, a lean credit file, lower income etc) means that they can be ‘down sold’ a weaker product – meaning credit card issuers can make the most from the limited number of leads. It also means that issuers can make their highline rates (the main advertised rates) as competitive as possible, and therefore attract the best possible customers.
People who are aware that they have imperfect credit or limited credit history should pay extra attention to the ‘down sell’ rates that are normally detailed in the issuers’ terms and conditions.
Typically, balance transfer credit cards have a longer interest free period on balance transfers than on purchases, so it’s important to avoid additional spending on the card to avoid paying higher interest than is necessary.
Although, since 2010, issuers have been legally obliged to use payments to clear the most expensive credit card debt first, having purchases charged at double digit interest rates whilst balance transfers are at 0% does little to help clear the main debt (which is what people should really be using balance transfer cards to do).
In most cases, cardholders are unable to transfer balances between two cards within the same bank or banking group. For example, Lloyd’s customers will not be able to transfer debts onto a Halifax credit card (they are both part of Lloyds Banking Group). It’s important to bear this in mind when comparing balance transfer cards as multiple credit card applications can reduce your credit score, so it’s important that you don’t apply for a credit card that you can’t use for the reason you applied for it.
Make your minimum payments!
When using a balance transfer card the most import thing to remember is that you must make your minimum payments on time if you want to continue to benefit from the deal you have applied for.
Although some loan suppliers offer a grace period, nearly all credit cards, including balance transfer credit cards, have a minimum monthly payment requirement, usually expressed as a percentage of the outstanding balance and typically ranging from 1 - 3% of the balance. If you do not pay this, or you pay late, you will be reverted to a standard interest rate.
Many people don’t pay much attention to standard Representative APR’s when applying for a credit card (being blinded with positive thought about how they are going to avoid paying interest), but they will certainly notice when the interest on their bill leaps up, due to a failure on their part to meet the terms and conditions they have agreed to. If you can, it’s worth setting up a direct debit to avoid missing monthly payments as the consequences of missing a payment are severe!
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