A balance transfer can help you sort out your credit card debt, so long as you don’t fall for the traps.
If you’ve got a credit card, there’s a one in six chance you’re struggling with credit card debt, according to a report by ASIC (the Australian Securities and Investments Commission) in July 2018.
If that’s you, perhaps you’ve considered using a balance transfer to help you pay off the debt and save on interest.
A simple search for balance transfers online will see you bombarded with products offering 0% balance transfers for X months, which sounds great, but there’s often more to a balance transfer than just a 0% interest offer.
ASIC’s review of credit cards found that 30% of balance transfer users in Australia actually increased their credit card debt by 10% or more.
This is because there are a number of things that can cause people to fall off the balance transfer tightrope, and they often aren’t made obvious to customers. We’ve summarised three of these traps below.
Balance transfer trap #1 – not paying off the balance in time
Balance transfers can be seen as a ‘get out of jail free’ card, but this is only for those who are disciplined (and nothing is ever really free!). Balance transfers can have introductory rates as low as 0% for as long as 26 months – a long time to pay off existing debts. But failing to pay off the full amount before the end of the balance transfer period can see you hit with a high revert rate.
A revert rate is the interest rate the card swaps to once the introductory period is over. Some refer to these as ‘nose-bleed rates’ because of how high they are. While the average credit card interest rate is around 17%, balance transfer revert rates average around 20%, but can be over 24%!
If you manage to use the balance transfer for its intended purpose and fully pay off your existing debts before the end of the introductory period, these revert rates won’t be a problem, so they’re a good motivator!
Banks bank on you not paying off the full amount
You might be questioning how a card that’s designed to help you save can be beneficial for the provider. After all, if you’re not paying any interest (with a 0% balance transfer) then what good are you to them?
The fact of the matter is that many Australians suck at paying off credit card debt, and unfortunately, 12-26 months isn’t long enough for some people to do so.
Let’s say there’s someone who has $4,000 in credit card debt. That’s a lot of money, and they’re already struggling as is, paying only the minimum monthly repayment of 2.5% of the balance each month. They think that switching to a 0% balance transfer for 24 months will help them save, but if they keep making only the minimum monthly repayments ($80 in this case), then they’d only have paid off $1,600 by the end of the balance transfer period.
With a revert rate of 21.99%, that remaining $2,400 would take 18 years and 11 months to pay off at the same minimum repayment rate, and would accrue more than $4,700 in interest to boot.
The lesson: if you get a balance transfer, pay it off before the end of the introductory period.
Source: The Checkout
Balance transfer trap #2 – making purchases with your balance transfer card
Another common way people fall into a balance transfer trap is by using the card to make purchases.
Why is this a problem? If you have a balance transfer owing on a credit card, you may not get any interest-free days on purchases you make. This means you’ll be charged interest from the date of the purchase, usually at the standard purchase rate on the card, which can be higher than 20%.
The lesson: balance transfers are meant to eliminate debt, not add to it, so do your darndest to not do any spending with it. If you must, then at least factor this extra debt into your monthly repayments each time.
Balance transfer trap #3 – forgetting about the fees
While we’ve primarily focused on the interest rates charged on balance transfers, you can’t forget about the fees they charge too. They’re easy to forget about though, especially when the fees are almost never made as obvious as the big flashing 0% interest offer.
Annual fees are extremely common on credit cards and can be as much as $750 on some of the more lucrative products out there. But for a ‘no frills’ cards with a 0% balance transfer, there are plenty of options with annual fees under $100. Some have no annual fee!
There’s also the balance transfer fee. The balance transfer fee is the handling cost associated with moving your balance from one card to another. Rather than a flat fee, it will usually be about 1-3% of the total balance.
If our hypothetical example person from above opens a balance transfer card and transfers $4,000 of debt, they might have the following fees:
- An annual fee of $70
- A balance transfer fee of $80 (2% of $4,000)
That right there is $150 worth of fees just to start paying off your debts. Not the best way to start.
The lesson: you should definitely check the PDS (product disclosure statement) for any balance transfer you’re thinking of using – they might have some fees hiding in plain sight. A high balance transfer fee can defeat the purpose of a 0% balance transfer too.
|According to a 2018 survey by SocietyOne, of Aussies who took out a balance transfer:
Other issues with balance transfers
These three traps are really the major pain points with balance transfers, but there are a couple of others that are worth talking about.
Not getting approved for your whole amount
Let’s say you’ve got $4,000 worth of debt (again). Depending on the card you’re switching to, you’ll usually be able to transfer between 70% and 100% of the new card’s credit limit. So to transfer that $4,000 worth of debt, you’d need to be approved for a balance transfer card with a credit limit of at least $4,000, although if the credit card provider limits balance transfers to 80% of the credit limit, you’d need a credit limit of $5,000.
If you had to transfer larger amounts of debt (let’s say $7,000), then you’d need a card with a higher credit limit.
Your credit limit is decided by the provider based on your credit history and income, so you, unfortunately, you may not be approved for the credit limit you need to balance transfer the full amount of the debt.
If your approved credit limit isn’t high enough, then you can still transfer as much as you possibly can to take advantage of the low interest. And after you’ve waited a little while you could balance transfer the remainder to a different card, remembering that applying for too many cards in a short space of time can be damaging to the old credit rating.
Keeping your current credit cards
This isn’t so much a problem with balance transfers as it is with the people who use them. Balance transfers can be a highly effective way of clearing debt, but you can easily end up back in the same situation if you continue to spend recklessly on your old card.
Keeping your old card can be useful to help you avoid the temptation of spending on the balance transfer card and instantly attracting interest though.
Savings.com.au’s two cents
There’s no denying that not paying any interest for one to two years (with a 0% balance transfer) can be extremely helpful in paying off credit card debt, especially if you’re being charged through the nose in interest with your current provider. But balance transfers are really just a way of kicking the can down the road, as they say, and there are two main things you need to consider:
- You still have debt sitting there, and it’s just waiting for the honeymoon period to end before it charges you even more interest
- There’s a reason why you needed to use a balance transfer in the first place
Think about that second point carefully: how did you end up in that situation? Are you spending too much on your credit card, or buying too frequently? Do you miss repayments? Or are you experiencing financial hardship in general, and your credit card bills are just one of many?
Whatever the reason, balance transfers are a short-term solution to a long-term problem. Consider cutting down on credit card spend in the future or find a more suitable card. ASIC found that Australians could save $621 million in interest repayments with lower-rate cards, so why not think about switching?