One of the most frequently asked questions is why we don’t recommend balance transfer cards. Most people tend to use these types of cards as a vehicle for debt as opposed to getting out of debt.
What is a balance transfer?
Before we dive into use cases, let’s define what a balance transfer is.
A balance transfer is when you transfer the balance from a credit card to another resource, typically another credit card or a checking account for a low-interest loan.
Most people use balance transfers to pay off credit cards with a high-interest rate.
The following are four use cases where it makes sense to use a balance transfer card.
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1. Interest arbitrage
Most balance transfer cards have a fee of 3% upfront. You have to pay the fee upfront. One of the good use cases is interest arbitrage meaning you’re making more than the 3% fee.
For example, if you have a high-interest checking account (5%+) like the Northpointe UltimateAccount, when you balance transfer $10,000, you’re paying a $300 fee, but you can make $500 or 5% back. You’re paying a $300 fee to get $500, netting $200.
Interest arbitrage ideal of CD accounts or high interest checking accounts. If your balance transfer fee is 0%, then you’ll net more than the 2% from the example above.
Things to consider:
- Credit score impact. Having a high balance transfer increases your credit utilization, which can have a negative impact. The ideal credit utilization is less than 10%. For example, if your total credit limit is $11,000 and you take out a $10,000 balance transfer, the utilization rate is 91%.
- Minimum payments. You need to pay off part of the loan every month. There is a minimum balance due each month, so you need to have the liquidity for payments. If you don’t have liquidity, don’t take out a balance transfer or you’ll only incur more debt.
2. Pay off credit card debt
If you have a few credit cards that have a high-interest rate, this would be a good way to bring the interest rate down.
For example, if one card has a 19% interest rate and another one has 0% (technically 3% with the balance transfer fee), then it makes sense to transfer the balance.
Beware of a few traps:
- Don’t pass the buck. Some people see balance transfers as a way to delay inevitable debt. Instead of paying a portion of the debt each month, they put it off for 12 months. In 12 months, they didn’t save money to pay off the debt completely, so they look for another balance transfer card.
- Every time you transfer the balance to a new card, you’re paying a 3% fee. There’s also the risk that no one else will issue another balance transfer card because of the debt.
- Pay off as much as you can each month, ideally more than the minimum requirements.
3. Dealing with a tough time in life and need a loan
Life happens. Be sure to cut down on expenses like food and entertainment, and set a strict budget during this period. A balance transfer is still a loan you’ll need to pay off.
Once you’re back on your feet, we recommend paying off the balance in full and saving up for a rainy day.
4. Getting an asset that makes you money
The final scenario where it makes sense to get a balance transfer is if you’re investing in an asset that will increase earnings.
An example of this is if you are a photographer and need specific equipment for a 3-month signed contract. You don’t want to put it on your credit card because you won’t be able to pay it off until the contract is complete. In this scenario, you know you’re going to have the money to pay it the balance transfer in full after three months.
On the flip side, we don’t recommend taking this route if you’re not a professional photographer or if you don’t have a signed project deal.
Another example is if you want to build a bitcoin miner and you don’t have the capital to pay upfront. You know you’ll get a return on the equipment eventually, but it’s still a gamble because there are factors like mining efficiency and the volatile cryptocurrency market. There is a possibility you’ll lose money.