A few years ago, one of my dad's co-workers was complaining to him about a shady practice you'll find with stores that sell big ticket items – TVs, engagement rings, furniture, home theater systems, etc.
It's called “0% deferred interest finance.”
Deferred interest finance is when they give you 0% for a set promotional period but charge all of the accrued interest if you don't pay off the entire balance before the promotional period ends. That's why you'll often see this advertised as “no interest if paid in full” or other similar language.
Let's say you buy an engagement ring for $5,000 with 0% deferred financing for 12 months. If you pay off the $5,000 within 12 months, you pay no interest. If you don't pay off the balance by the 366th day, you are hit with all of the accrued interest during the promotional period.
It's not as expensive as paying interest along the way but it's certainly very very far from 0%.
My dad's co-worker bought a home theater system and was only a few hundred dollars away from paying off the whole thing but only had a week or so to do it – far too short a time period for her. If she could, she'd avoid hundreds in deferred interest charges.
So he suggested that she try a 0% balance transfer, which he knew about because it was a popular blog post on my previous blog. Her credit was good so she was approved immediately and her problem was solved. She did a 0% balance transfer, paid off the deferred financing, and wasn't left paying hundreds of dollars extra in financing charges.
For her, the 0% balance transfer was a valuable tool that saved her hundreds of dollars.
If you're considering a 0% balance transfer, here's what you need to know:
What is a 0% balance transfer?
A balance transfer is when a credit card writes you a check to pay off an existing debt. The balance “transfers” to the credit card through the flow of funds.
What's the benefit of a simple transfer of balance? You usually do this when the new account offers a lower interest rate than the old account.
With a 0% balance transfer, the credit card is saying you'll pay 0% interest on that balance for a set promotional period. The promotional period is typically 12-18 months. This gives you a year to a year and a half to pay down principal since there is no interest being charged.
The “gotchas” of balance transfers
There are three things to watch for when it comes to a 0% balance transfer offer.
1. Balance transfer fee – It's fairly standard for a credit card to offer 0% on the balance but collect 3% of the transfer as a balance transfer fee. If you get lucky, this fee may be 1% or even 0%.
2. Interest rate after the promotional period – After the promotional period, your interest rate will be set at their prevailing rate for your credit profile. It's important you understand what that rate is before you take advantage of the offer. If you're transferring from one credit card to another, it's likely that your rates will be similar and so you're just getting a 12-18 month break on interest. The credit card still makes money after the promotional period, assuming you don't pay it off completely, because now you're sending those payments to the new card and not the old one!
If you're transferring a balance from a lower interest rate loan, it's important to know the interest rate difference.
3. New purchases are not at 0% – When you carry a balance on a card, you lose the grace period and all your payments are going towards the balance. This means any new purchases you make with a card will be assessed the non-promotional interest rate. You also cannot pay down the new purchases directly, all your payments will go towards the promotional balance.
If you do a balance transfer, you should not use that card until you've paid off the balance transfer or you'll be charged interest on all those purchases.
4. Low credit lines – It's not uncommon for a credit card to issue you a low credit line to start, especially if you're carrying balances elsewhere. We discuss strategies to combat this but just be aware that you could be surprised with a low line of credit.
5. Some cards write you checks, others will only do transfers – Some credit cards will actually write you a check that you can deposit and then pay off your other balances on your own. Others will only pay the cards directly.
Do not confuse this balance transfer check with a cash advance or some other method (the names change). Do not get a cash advance, that's not a balance transfer and won't be subject to the 0% APR. Make sure it's a balance transfer check.
The only reason to get a 0% balance
The only reason you should use a 0% balance transfer is to aggressively pay off high interest debt.
It's a tool that you should use in conjunction with other debt paying strategies to get you closer to a debt balance of $0.
If you think you can just move your balances from one card to another, building your own little credit card debt Ponzi scheme, you can… until you run out of options. Then your credit will be worse off because of all the credit card applications, your debt situation will likely be worse, and you will no longer have this valuable tool in your kit to combat debt. Only use this to get you closer to paying off your debts.
Now, whether you use the debt snowball (pay low balances first) or debt avalanche (pay high interest rates first), you should treat the transferred balance as the high interest debt it really is. If you transferred it from one credit card to another, calculate your payoff strategy using the balance's non-promotional rate.
For example, let's say you had these three unsecured consumer debts:
- Debt A: $500 at 12%
- Debt B: $1000 at 16%
- Debt C: $3000 at 18%
Under debt snowball, you'd be paying Debt A because it's the lowest balance.
Under debt avalanche, you'd be paying Debt C because it's the highest interest rate.
If you transferred Debt C to a 0% balance transfer, your debts now look like this:
- Debt A: $500 at 12%
- Debt B: $1000 at 16%
- Debt C: $3000 at 0% (for 12 months, then rises to 18%)
Under debt avalanche, you should still treat Debt C like it's has an interest rate of 18% and aggressively pay that loan off first even though technically the interest rate is 0% for 12 months.
Should you consolidate with a balance transfer?
Maybe.
It hinges on how aggressively you can pay off debt and the non-promotional interest rate of the new card.
Let's say your debts are:
- Debt A: $500 at 12%
- Debt B: $1000 at 16%
- Debt C: $3000 at 18%
The easiest scenario is if the new card's interest rate is under 12% – then you definitely want to consolidate because it's still cheaper after the promotional period.
The next easiest scenario is if the new card's interest is over 18% – then you only want to transfer the balances (less the transfer fee since that's tacked on) that you know you'll be able to pay off within the promotional period.
The tricky in-between scenario is actually not that tricky. Any balance that has an interest rate above the new card's rate will get transferred, since it'll be cheaper even after the promotional period. Any balance with a lower interest rate should only be transferred if you intend to pay that amount off before the promotional period ends.
Let's say you think you can pay off $1,000 in the promotional period and the interest rate of the new card is 17%. You will transfer all of Debt C and Debt B.
You transfer Debt C because it's cheaper by a 1% (remember, you're still making minimum payments and paying down the debt, so you'll still save 18% interest less the transfer fee). You're also able to pay an extra $1,000 over the course of the year, which would clear out all of the Debt B, which has a rate that's 1% less than the new card.
At the end of the promotional period, assuming a 2%/$10 minimum payment, you'd have:
- Debt A: $436.60
- Debt B paid off
- Debt C: $2354.15 plus $120 balance transfer fee.
That's a total debt of $2910.75 after $1765.84 in payments. (A: $120, B: $1000, C: $645.84).
If you didn't transfer, assuming a 2%/$10 minimum payment, you'd have
- Debt A: $436.60
- Debt B: $95.62
- Debt C: $2824.88
That's a total debt of $3357.10 after $1820.47 in payments. (A: $120, B: $999.96, C: $700.51).
And Debt C is now at a lower interest rate.
Do the math and you'll know whether you should do it.
Why you shouldn't get a 0% balance transfer
Unless you have a plan for aggressively paying down your debt, a 0% balance transfer isn't going to help too much.
There's a cost to the balance transfer, usually 3-5%, that is due immediately. It's called a fee but you can think of it as interest on the transfer. If you transfer $10,000, you'll owe $300 in fees. If you have a card charges you 15% interest and you have a $10,000 balance throughout the promotional period, transferring that debt will save you a little under $1500 in interest charges. That's a good trade, to save almost $1500 in interest by paying $300.
There's also a secondary cost to your credit score because the credit card application will result in a hard inquiry. Hard inquiries lower your score for a short time but are often worth it if you're getting something beneficial, like a break on interest.
The promotional periods are usually only a year or so. The best offers might top out at 21 months, which is three months shy of two years, but those are rare. If you just plan on making minimum payments, a 0% balance transfer will help but not significantly. If you plan on aggressively paying off those debts, that's a far better plan.
How to maximize the balance transfer
If you've decided to get a balance transfer, you need to know how to make the most of it.
We've already talked about how you should only use it if you've decided to aggressively pay down your debt.
Beyond that, here are a few more tips:
1. Don't make any purchases on that card. Remember, the balance transfer is at 0% but new purchases are at the non-promotional APR. You will be paying interest on those purchases immediately and you won't get the option to pay them off before the transferred balance.
2. Check the credit line. A lot of those pre-approved mailers that say you can get a 0% balance transfer will throw out big credit limit numbers at you. Those pre-approvals are not worth the paper they're printed on. You're certainly pre-approved but the classic “up to” figure means they can say $10,000 but then stick you with just $1,000. Make sure you get a credit line that will benefit you financially.
If you are given a low line, ask for a higher one. A lot of the approvals are automated and you may have luck getting a higher limit if you talk to a customer service representative on the phone and provide details as to your needs.
It's important you explain that you want a higher line because you're transferring a balance. This is a very common use case and may be the key to getting a higher line.
3. Shop around for the best terms. Credit cards are very aggressive in their marketing so make sure you get the best combination of credit limit, balance transfer fee, promotional period, and interest rate after the promotional period. You should be able to get, at worst, a 12-month 0% balance transfer with only a 3% transfer fee if you have good credit.
