Have you received your credit card bill for December yet? If so, you're not the only one. As this Federal Reserve Board chart shows, Americans accumulate about $30 billion in credit card debt in the last quarter every year – and then attempt to pay it off in the first quarter of the New Year.
The problem is they rarely succeed at paying off the entire balance. By the end of the first quarter every year, roughly $6 billion of revolving consumer credit is still unpaid. Even worse, it usually continues to grow the rest of the year too.
A harsh reality made worse
It's never pleasant to face the fact that you may not have budgeted your purchases very well (or at all) during the holidays. But the harsh reality is how quickly debt increases if it isn't paid off completely. And with interest rates on the rise, it can only get worse.
It might not be deferred holiday spending that tripped you up, though. Mistakes happen – especially when you're just starting out – and unexpected events pop up all the time. (Take me, for example – my home heater died today, even though it's only two years old!).
But if you have to put an uh-oh purchase on a credit card – on top of the holiday charges you've already made – you may be wishing you had a way to stretch your budget and pay it all off.
Is a balance transfer credit card the answer?
A balance transfer credit card may be a really good option in this situation; but there is a lot to know about how these offers work. And if you're not clear on all of the terms of the particular card you're interested in, your financial condition could very easily make a turn for the worse. It's not as simple as you might think, so here's what to consider:
- Your credit rating. The most attractive balance transfer offers are extended to those with excellent credit. If you have excellent credit, usually in the mid-700s to 850, consider applying for one of these cards. If you are in the lower end of the credit spectrum, however, the offers are usually less generous. Regardless, it's important to know what happens during the introductory period.
- Introductory periods. This is where you can really make progress hammering down your debt. Most offers include an introductory period with 0% or a very low interest rate. Most offers I've seen have a 0% promotional period of only six months to a year. What term length you pick may depend on factors such the following points…
- How long you need to pay off the debt. Do you just need three months to pay off the balance because you expect a tax refund in April or do you need as much time as you can get because you can only afford $30 a month? Knowing how long it will take to pay off your balance is critical to comparing balance transfer offers, but so is the next item.
- Interest rates. Remember that introductory period with 0% interest? Well, that rate is temporary. And it may only apply to the balance you transfer within a certain period of time, not to any new purchases you make with the credit card.
Make sure you understand how the interest rate changes to know if it even makes sense to move the debt around. Typically, the higher the interest rate on your current debt, the more likely transferring the balance would make sense. Interest rates vary widely between credit card companies too, so you really need to dig into each offer and see which is best for you.
- Credit limit. Are you transferring your entire balance from other high-interest debts to simplify your finances and consolidate them onto this one card? A credit card company may only approve a smaller credit limit, which could leave you juggling payments on other debts in addition to this new card. While it may not be the perfect solution, reducing the amount of interest you pay – even if it's only a portion of your debt – might still be worth it.
- Balance transfer fees. Any fees you pay to transfer the balance will reduce the amount you could save in interest, so calculate what that amounts to when comparing offers. Most cards I have seen in the recent past had a 3% balance transfer fee and some are as high as 5%; but some have a $0 balance transfer fee for a certain period of time and others don't even have a fee at all.
- How payments are applied. This is a big gotcha that most people fail to consider, and it's an expensive one at that. If the credit card company applies your payments to the lowest interest rate balance first and the excess to higher interest-rate balances, uh-oh. That means your payment will be applied to the 0% balance first, allowing new purchases to accrue interest at the much higher rate!
What else matters?
- Adopting an attitude toward debt. It's easy to get into problems with credit, but I don't believe credit cards are necessarily a problem for everyone. I think it all comes down to the attitude you have toward debt. If you loathe debt, want to be debt-free, and know you have the discipline to stay debt-free, moving debt around with a balance transfer offer can help you pay a balance off as quickly (and inexpensively) as possible.
- Putting the shovel down. This is your pay-it-off card. Putting new stuff on this card is like digging a deeper hole. Don't do it. Instead, commit to not making any new purchases after the balance is transferred.
- Staying disciplined to pay it off in time. In other words, don't pursue a balance transfer credit card offer if you have any doubts about your resolve or ability to pay the balance back in time. Be disciplined to get rid of the debt in the allotted time – otherwise, you could be left paying a higher interest rate on your balance.
- Keeping your credit healthy. A balance transfer credit card offer may be a good way to eliminate debt once and for all, but transferring debt repeatedly from one balance transfer card to another can hurt your credit in the long run. The point is not to keep moving debt around; it is to help you get rid of debt entirely.
- Reading the fine print. Most cards offer 30 to 60 days to transfer balances; so as soon as you apply for the new card and get approved, set time aside to read the fine print … in its entirety.
Make a repayment plan — and plan for the future
- Budget to repay the debt as soon as possible. Don't fall into the trap of waiting out the complete 0% period. You never know what unexpected expenses could pop up. Instead, make a plan for how to repay the debt so you don't end up owing money at a huge interest rate.
- Set up automatic payments. Formalize your plan with automatic bill-pay to make sure each payment is taken care of before you reallocate that money for something else.
- Monitor your credit card statements. Make sure that you're making progress every month and that no unexpected charges or fees are being added to your balance.
- Start an emergency or a targeted savings account right away. What helps prevent a debt spiral? An emergency fund! Take this time to work on building your online savings account. Hopefully that will make it so you won't have to go through this again.
You don't have to resign yourself to making payments on an ever-increasing balance. With a little bit of thought, shopping, and commitment, you can reverse the trend line of debt. Better yet, you could start to save for this year's holiday season in advance, build up your emergency fund, or even start working on a new Roth IRA.
Has a balance transfer credit card helped you completely eliminate debt or have you had a card turn into a debt horror story? What tips can you share? What do you think makes a balance transfer a good strategy?