A member asked the question today about how a balance transfer works and does it help anything, other than possibly lowering the interest. Usually, people take on a balance transfer because they got a nice 0% deal. It’s not very often people ask whether this is helpful to their credit, so I thought I’d talk about it here.

So, here are the basics. A balance transfer is simply what it states. It’s taking the outstanding balance of one card and moving it to another card. This is usually done to save money on the interest, though some people will also use this method to consolidate debt as well. Most likely there is a balance transfer fee somewhere in the 3% range, though most credit card companies will put a ceiling on the amount. Chase, for example, caps their fee at $75.

Personally, I wouldn’t consolidate other debt to a credit card unless it was a locked in rate. If you’re getting 0% for 18 months and you know that going in, then great. That’s a deal to take advantage of. However, if your card doesn’t have a guaranteed time frame, in addition to the lower rate, then it may not be beneficial to transfer to that card. If there’s not a promotion attached, the credit card company could very well raise your rate and then the transfer becomes completely pointless.

On to the specifics. Does a balance transfer help your credit? That depends. There’s no black and white answer to this question. So, here’s how it goes. Your FICO score is broken into a points system based on their formula: 35% payment history; 30% amounts owed; 15% length of credit history; 10% new credit; and 10% types if credit used. Now, since we’re talking about balance transfers, that’s going to fall under the amounts owed category.

Generally speaking, the lower the amounts owed section of your file is, the higher your points in that area. But, your ratio of debt-to-limit on your credit accounts is also taken into consideration. So, while you may only have $5000 outstanding debt – comparatively low for the average American – if all of your cards are completely maxed out, you may have a lower score than your spouse who may have five cards sitting with a combined balance of $16,000.

In terms of this ratio, credit scores are typically at their highest when the ratio is around 25-30%. Anything higher than that and your score starts dropping. So here’s where it’s difficult to say whether a balance transfer helps your score or not. If you have four cards with a total balance of $50,000 on them and you apply for a fifth at 0% to transfer the balance of two of them over – let’s say in the amount of $25,000 – you’re not really helping your score here. Yes, you’ve lowered your interest rate on two cards and combined their payments. This will eventually help you to help your score, but the act of transferring the balance itself did not help you.

Why? Because your ratio is still the same. You’ve only shifted the balances from one card to the next. In fact, because you’ve applied for new credit and added a new line to your debt-to-limit ratio, you’ve most likely decreased your score at this point.

However, if you pay one of these cards off completely – let’s say $15,000 – that leaves you with a total outstanding balance on those four cards of $35,000 (based on the original example). Does this help? Well, no. You’re still at 70% on your ratio, and remember, credit scores are at their best when the ratio is 25-30%. You’re on the right track, and paying off your debt makes you feel accomplished, but by itself it doesn’t increase your score a whole lot of points.

With four cards totaling a credit limit of $50,000, you’d need to get your debt at around $12,500 to see a significant increase in your scores. So, do balance transfers help your credit score? Not directly. But, they do put you on the path to increasing your scores by allowing you to lower your interest and make more payments, or by consolidating your payments into one.

Something else to remember too is that if you’re transferring balances around on your credit cards, be sure you don’t start closing a bunch of cards down. This can impact your score as 15% of it is based on the length of credit. If you have a card for 10 years and you close it, that’s 10 years of history gone. You can bet your score will take a hit for that. On the flip side, it’s important not to have too much credit available, either. Lenders get a little concerned when they see a lot of available credit on a revolving variable rate instrument. So, if you’re intending to make a major purchase, what you might want to consider instead is calling your lenders and asking them to lower your limits.

How do you guys feel about balance transfers? In your opinion, are they worth it, or just another scam by the credit card companies?

Related posts:

1. Balance Transfer Checks: A Breakdown
2. 0% Balance Transfer Credit Card Offers
3. The Scoop On Balance Transfer or (In)Convenience Checks
4. Make your credit card work to keep you!
5. How to Balance your Checkbook…