How a balance transfer to 0 percent card affects score

It will help you pay down debt, but maxing out the credit limit can hurt

Speaking of Credit columnist Barry Paperno
Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes "Speaking of Credit," a weekly reader Q&A column about credit scoring and rebuilding credit, for CreditCards.com. His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.

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Question

Dear Speaking of Credit,
My wife and I have recently gotten our scores into the 700s again. We both got new cards. Mine is 0 percent APR for 21 months. Hers has great flight miles (she has higher-interest cards she would like to transfer to hers as well).

But when I use Capital One’s credit score simulator, it says I would kill my score by 40 points if I transfer balances to the new card. The same thing happens to my wife’s score.

My old cards have high interest. Everywhere I read, it says balance transfers should not hurt.

I’m very concerned about this. What gives? Thanks in advance for your time. – Scott

Answer

Dear Scott,
It’s good to hear of your successful credit rebuilding results. You’re now experiencing at least one of the perks of a higher score: qualifying for a 0 percent balance transfer card. Good work!

So, why if your score is supposedly on the upswing should it then drop by 40 points, as the simulator predicted, when all you’ve done is move existing high-interest balances to a new lower interest rate card?

Credit scoring impact of balance transfers

Actually, your credit score following a balance transfer doesn’t have to be bad. A balance transfer can lead to a higher, lower or unchanged score.

However, with your question in mind, let’s focus on how your score can fall, at least slightly, in this situation by examining some of the factors that can lower a score following a balance transfer.

In doing so, we will assume only these changes to your credit reports:

  • A new highly utilized (balance transfer) credit card and the hard inquiry leading to it.
  • A paydown of the older card from which the balance was transferred.

New card, high utilization, hard inquiry

While the new card doesn’t have to show a high credit utilization ratio – the amount you have borrowed compared to the card’s credit limit – chances are you’re going to want to move as much of your higher interest debt as you can to that new 0 percent card.

The score aside, it only makes sense to apply more of your payments to principal reduction and less to interest.

Yet by following this sensible strategy, you could max out the new card or come close to doing so, resulting in high credit utilization (well above 50 percent) for that individual card.

But the impact to that card won’t be the whole story. There are a couple of different ways utilization is calculated and evaluated within the “amounts owed” scoring category that makes up 30 percent of your score:

  • Individual card utilization. These calculations look at how you manage each card, with, as always, lower utilization indicating lower risk and a higher score. No matter how much of your total available credit is being used, a highly utilized card or two in the mix can prevent your score from being as high as it would otherwise be, if that same total utilization were achieved through low utilization on all cards.
  • Total combined utilization. While individual percentages do matter, the weight of your total combined card balances against your total combined credit limits tends to be the stronger risk predictor. Therefore, of these two ways, your total combined utilization will exert the most impact on your score.

As an example of the above explanation, it’s better for your score to have a 25 percent combined utilization achieved by two accounts, each at 25 percent utilized, than to reach that same 25 percent combined utilization percentage with one account at 0 percent and one at 50 percent.

New account and hard inquiry

When added to the hefty impact of credit utilization, there are two more factors to consider.

The presence of a new account and the related hard inquiry on your credit report could cause the loss of more points within two score categories:

Each category makes up 15 percent and 10 percent of your score, respectively.

Good credit utilization news

Fortunately, over the longer term you are likely to see more positive than negative results when transferring balances in this way.

Most importantly for your score, this new card opening adds available credit to your score’s total combined utilization equation.

 

Video: What is a balance transfer credit card?

When left with the same total balance as before the transfer, the addition of this available credit alone can result in a lower combined utilization percentage – and a higher score.

Let’s not forget that you’re also paying off, or at least down, that older card from which the balance is being transferred. As long as you leave that card open, keep it reasonably active and the balance low, your score can continue to reap the benefits from its positive and lengthy history for years to come.

The passage of time helps credit scores

When your credit score is at stake, remember that time is likely to be on your side. By having your 0-interest card payment applied entirely to the principal and none to interest, you’ll lower that balance and utilization much more quickly than when interest consumes much of your payment.

Also, the passage of time will help age that new account and inquiry. By the card’s first birthday, its utilization will be reduced and the card will no longer be considered new. This means that the hard inquiry will be ignored by the score entirely.

Nice job working on your credit

Regardless of what immediate turn your scores take when those balances are transferred to your new 0 percent card, you’ve done well.

First, by rebuilding your scores; then, by strategically moving higher interest debt to a lower interest card. This will both save on interest and enable you to apply more of your monthly payments to those card balances that so strongly determine your credit utilization.

Keep up the good work!

See related: Q&A: How to combine existing card balances without hurting score, How to avoid 5 traps of balance transfer cards

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Updated: 12-15-2017