Balance transfer credit cards - what's wrong with them?

A balance transfer credit card is seen as a good way to help get out of credit card debt, as you can get a card that has a much lower interest rate, possibly even 0%. 

Lower interest is good, but is this actually a solution for clearing debt?

Maybe, if you do it properly. Something to realise is that the balance transfer card is not THE solution, but simply a cheaper way of using good habits to solve the debt issue.

Too often the new bank is just buying your debt, assuming that within a short time you will be maxed out with them, paying full interest.

How they work:
The bank offers to give you a credit card with a much lower interest rate (often 0%), for a period of time (often 12 months), that pays off your existing credit card (though sometimes they will roll in overdrafts, car loans, personal loans etc).

This gives you 12 months of not having to pay interest, which in theory means you can pay off the card, or at least reduce the balance owing by a lot, before the interest kicks back in.

Whats wrong with them?
Part of the problem is that they are seen as the solution, they get the card, don’t change any habits, and in a short period of time, they owe just as much as before at full interest but to a new bank.

Its how the payments work. You still have to make a minimum payment each month.

When you make a payment on to the card, the money sits there as available funds that you could spend. And because its at 0%, there is even more money there than before, since there is no interest payment.

And here is where the bank traps you. If you use the card at all, the new purchase is charged at full interest, eg 21%. And this part of the debt is paid off last.

So if you spend $100 on a card owing $1000, you have to pay off the 0% $1000 before you make any reduction to the amount owing 21%. So you pay interest. (note that some cards do not have this provision, but most do).

So for most people, they get the card and over a few months, most of the card is back to full interest. Simply put the new bank bought your debt, knowing you would be back at full interest in a short time frame.

Do you have to pay it off in 1 year?
You have 12 months of 0% interest before the card reverts back to standard interest (some cards are different, but this is the norm). Ideally you would pay it off in that year, but this is not always doable.

What you do is, once you are at the end of the year, go to another bank and get a new balance transfer card, use it to pay off the old one, and start the process again.

Keep doing this until the card is paid off. Remember to reduce the limit every month.

How can you make them work?
If you are going to get a balance transfer card, here is what you do:

1.       Pay off and close the original card/s so you don’t just double your debt

2.       Cut up the new card and get the bank to freeze it.

3.       Make regular payments to the card, but never use it.

4.       Reduce the limit every month as you make payments

5.       When the 0% interest period ends, take the card to a new provider doing the same deal, and start from step 1 again.

6.       Repeat till the card is paid off and closed.

A balance transfer card can help save you some interest while you pay off your credit card, but they are a way to maximise your plan, not the solution in their own right.

To make them work, you need to change your habits, stop using the card and commit to reducing your debts.

Alan Borthwick