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To Her Credit

How balance transfer cards help or hurt credit scores

Summary

Moving high-interest card debt to a 0 percent balance transfer card can help your credit scores, but only if you play by the rules

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Question

Dear To Her Credit,
Regarding the balance transfer offers one receives for six, 12 or 18 months at 0 percent interest: If I take advantage of one these offers and honor it for the length of time given (the said six, 12 or 18 months), pay it judiciously every month, and pay off the balance before the end of the 0 percent period, would carrying the balance for that period of time reflect badly on my credit?  — Emily

AnswerDear Emily,
Would entering into a contract, abiding by the terms and paying off the balance hurt your credit? Hardly.

If your credit history is a bit thin, such a course of action could even have a net positive effect on your credit score.

Credit scores are funny things, however, in that any action may affect your score in more than one way. Fortunately, we can predict the effect on your credit score by looking at how the credit scoring models work.

If you take out a new, 0 percent interest card and pay it off as planned over the 0 percent interest period, your credit score may be affected by these factors:

  • Hard inquiry: Little effect. Applying for a new credit card will probably ding your credit score by a few points when the lender pulls your credit score to look over your creditworthiness — a process known as a hard inquiry or hard pull. I wouldn’t worry about it. The effect of one hard inquiry is negligible. And it’s temporary.
  • One more card: Little effect. If you have more than a few cards, adding one more can send negative signals to the credit scoring model.  On the other hand, the credit scoring difference for having one more card is no big deal. I’d only worry about it if you are carrying big balances on your other cards.
  • Higher debt: Possible negative effect until it’s paid off. If you use the card to buy something and increase your total debt load, your credit score may go down during the time you carry that balance. This is especially true if you owe a good deal in proportion to your total available credit. A significant portion of your credit score is based on your credit utilization ratio, or the amount you owe compared to your available credit. If you have $10,000 in available credit across one card or several cards and you owe $5,000, your credit utilization ratio is 50 percent. Generally, a lower credit utilization ratio is better. Of course, when you get rid of the debt by paying it off, you will also get rid of any negative effect.
  • Higher credit limits: Possible positive effect. One way to lower your credit utilization ratio is to boost your amount of available credit. Using the same example, say you have $10,000 in available credit and you owe $5,000. Then you get a 0 percent card with a $5,000 limit and transfer all your debt to it. You now have $15,000 in available credit, and the same debt. Your credit score is improved because your credit utilization score is reduced to 33 percent. ($5,000 divided by 15,000 = 33 percent).
  • More good payment history: Positive! Here’s the one that matters the most. Thirty-five percent of your credit score is based on good payment history. By using a credit card properly, you prove to future creditors and other interested parties that you are financially trustworthy.

The net effect of getting this card, if all goes as planned and you don’t use it to rack up a lot of new debt, is likely to be positive. So what can go wrong?

For some people, a new card is an invitation to spend more. They plan to take this opportunity to pay down debt during the 0 percent period, but it doesn’t quite work out. By the end of the introductory period, they’re further in debt, and now high interest rates may kick in. They may try to get another 0 percent card for another shot at paying off their debt, but they can only play “hot potato” with credit cards for so long. Don’t fall into this trap.

You should also be careful of balance transfer fees if you’re planning to clear up other debt by transferring it to a new, 0 percent card. Some balance transfer fees are 3 percent or more, which is applied to your transferred balance and sets you back before you even get started on any debt repayment plan.

Whether you get a new card or not, remember that your total financial picture is more important than temporary five- or 10-point fluctuations in your credit score. Take good care of your finances, never miss a payment and your credit score should be fine.

See related:2015 Balance Transfer Survey: Offers more generous, but move fast

 

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