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Consumers seeking relief from high-interest credit card debt sometimes turn to balance-transfer offers to capitalize on an introductory 0% deal. Refinancing can be a smart cost-saving move, but it probably won’t go very far in helping your credit score — unless you pick the right path to paying down your debt.
What it really means to transfer a balance
A balance transfer means you’re moving debt from one credit card onto a different credit card, usually to take advantage of a lower interest rate. This doesn’t pay off your overall debt, and it doesn’t reduce the interest that’s already accrued. But it does stop new finance charges from accumulating on your balance for a period of time, assuming you opt for a balance-transfer card that offers an introductory 0% or low-rate promotion.
For example, let’s say you’re carrying a balance of $10,000 on a card that charges 15% interest and your goal is to pay it off in the next 12 months. By transferring it to a card that’s offering 12 months at 0%, you’d save $831 in interest.
Just keep in mind that you’re likely to incur an upfront cost for shifting your debt onto the new card: a balance-transfer fee. This fee is often 3% (and sometimes more) of the balance you’ve transferred, reducing your savings from the balance-transfer deal. In the example above, a 3% balance transfer fee would amount to $300, bringing your net savings down to $531.
That’s still a significant savings, but not quite as generous as it first appeared.
Nerd note: At least one credit card on the market comes with a long 0% APR period and gives consumers an option to avoid balance-transfer fees. Check out our review here.
Your credit score may improve, slightly
To get an idea of how a balance transfer will affect your credit score, you’ll need to understand a few basics about your credit utilization ratio. This ratio is simply the amount of credit you’re using divided by the amount of credit you have available.
This number has a heavy influence on the 30% of your FICO credit score determined by the amounts you owe.
You’re more likely to obtain a higher credit score by keeping your credit utilization ratio below 30% at all times. This is considered by the FICO model in two ways — per-card, and across all of your cards.
Let’s illustrate this with an example, and assume that a consumer has two credit cards:
- Card A: $2,000 balance with a $5,000 limit
- Card B: $1,000 balance with a $3,000 limit
This consumer has a 40% credit utilization ratio on Card A, a 33% credit utilization ratio on Card B, for an overall credit utilization ratio of 37.5% (for calculations, see the methodology section below). On each of her cards and overall, this consumer’s debt is over that 30% target.
One way to bring the ratio down would be to transfer the $2,000 balance on Card A to a new card, Card C. Say Card C has a 0% promotional APR and a $5,000 limit. Her credit utilization on Card A would fall to 0%, while Card C would assume the same 40% credit utilization ratio that Card A had originally. The FICO algorithm would look at her credit report and see a card with a high balance, which means she’d still be likely to get dinged for her per-card credit utilization ratio.
But the balance transfer caused her overall credit utilization ratio to drop to 23%, because opening Card C added $5,000 of available credit to her profile. This would cause her FICO score to rise a bit. But she’ll see 3-5 points shaved off her score in the short run because of the new credit inquiry from applying for the balance transfer card.
Another option for a bigger credit boost
Using a personal loan to refinance your credit card debt may be a good choice to save on interest and give your credit score a boost. Here’s why: Only the balances on revolving credit card accounts are factored into credit utilization ratio. So paying off credit card debt with a personal loan will immediately cause your utilization ratio to plummet and your FICO score to rise.
Again, the debt isn’t disappearing. But by converting it to a different type of loan, you’re making it look different (and better) to the FICO scoring model.
The major drawback to using a personal loan over a balance transfer credit card is that interest on the loan begins accruing right off the bat — there’s no introductory 0% period to save you big bucks up front. However, you’ll still likely get a lower rate on a personal loan than what you’re paying on your credit cards, and if you get a fixed rate, it will be locked in for a period of several years.
No matter which route to credit card debt refinancing you choose, be sure to make your payments on time and pay down the balance as quickly as possible. There are few things better for your well-being and your wealth than being debt-free.
To calculate the per-card credit utilization ratio on Card A:
$2,000/$5,000 = 0.4 (40%)
To calculate the per-card credit utilization ratio on Card B:
$1,000/$3,000 = 0.33 (33%)
To calculate the overall credit utilization ratio for Cards A and B:
$2,000+$1,000 = $3,000 (the balances on both cards combined)
$5,000+$3,000 = $8,000 (the limits on both cards combined)
$3,000/$8,000 = 0.375 (37.5%)
To calculate the overall credit utilization ratio for Cards A, B, and C:
$2,000+$1,000= $3,000 (the balances on all cards combined)
$5,000+$5,000+$3,000=$13,000 (the limits on all cards combined)
$3,000/$13,000= 0.23 (23%)
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