If you are struggling to pay off your debt, landing a lower interest rate on what you owe can make a big difference. Usually, balance transfer rates on credit cards can look very attractive. Plus, they might even be lower than what you have on your current personal loan. However, using a balance transfer to pay off a personal loan isn’t typically a great idea. There are risks with that approach, and terms might not remain favorable over time. If you are wondering why you shouldn’t use a balance transfer to pay off a personal loan, here’s a look at why it’s a bad idea.
That Introductory Rate Won’t Last Forever
In the vast majority of cases, balance transfer introductory interest rates don’t last indefinitely. You may have access to the promotional rate for just six months, 12 months, or 18 months, which isn’t a lot of time.
After the introductory balance transfer rate expires, you are stuck with the credit cards regularly interest rate, which is commonly much higher than the rate you’d have on a personal loan. The average credit card interest rate falls near 17 percent.
If your personal loan interest rate is lower than your credit card interest rate after the promotional rate expires, you could find yourself paying more in interest as you pay down the balance or hit with a higher payment down the road. Most credit card payments are a percentage of your balance along with the interest charges. When the interest rate kicks in, your monthly payment will almost certainly go up, and this can have a major impact on your budget.
By sticking with your personal loan, you get a level of predictability. Personal loans tend to have fixed payments over the life of the loan, so you know exactly what you’ll need to pay each month until the debt is gone. Plus, personal loans are finite. You know how many payments are left and when the last one happens, giving you a precise date as to when you’ll clear the debt.
Balance Transfer Fees
Balance transfers come with fees, usually 3 to 5 percent of the amount of the balance you are transferring. The exact amount varies from one bank or credit union to the next.
This fee isn’t spread out over time. Instead, it is added to the balance you owe the moment the balance transfer goes through. As a result, you significantly increase your debt immediately, and that isn’t always a smart move.
If you stick with your personal loan, you aren’t accruing any more debt. Any fees associated with the loan are already part of your balance, barring particular (and somewhat rare) exceptions, such as early payoff penalties that a limited number of lenders levy.
Credit Score Impact
Paying off a personal loan with a balance transfer impacts your credit score. First, once the balance transfer fee goes onto your account, your debt load increases. This can negatively affect your credit score.
Second, when you pay off the personal loan, that account usually closes. As a result, the average age of your credit accounts shifts. If the balance transfer credit card is a new account, your average account age will likely go down, negatively impacting your credit score.
Finally, moving a personal loan debt to a credit card also hurts your debt-to-credit ratio. That ratio is a reflection of the amount you owe on your credit cards as compared to your credit limit. The higher the percentage of your available credit limit that you use, the worst that ratio is in the eyes of the credit bureaus. As a result, your credit score can take a pretty big tumble depending on the amount of debt you transfer.
While the exact impact on your credit score will depend on your unique situation, it is important to understand that it could be both noticeable and negative. If you may need to open another credit account in the relatively near future, doing a balance transfer to pay off your personal loan could make that harder, not easier.
Qualifying Isn’t Always Easy
If you don’t have a balance transfer credit card and were considering opening one to address your personal loan debt, it’s essential to understand that this isn’t a guaranteed option. Many balance transfer cards require borrowers to have at least “good” credit, usually with scores of at least 680 or 700. Some won’t approve anyone with less than “excellent” credit scores, typically around 750 or higher.
Even if you can get a balance transfer card with fair credit, the terms usually don’t work in your favor. The promotional interest rate may only be available for six months. Plus, the credit card’s regular interest rate after that will apply, and it’s commonly pretty high.
Additionally, opening a new card also impacts your credit score. You’ll have a “hard pull” on your credit report (too many of which can hurt your score), a lower average account age, an adjustment to your total available credit, and more shifts that all cause your credit score to change.
Ultimately, using a balance transfer to pay off your personal loan can be a very risky move. Unless you can guarantee that you can pay off the entire balance (including the balance transfer fee) before the promotional rate expires, it typically isn’t worth pursuing. And, even then, there is always an impact on your credit report, and your score might go down. If you can’t ride out a period with a lower score, then this approach isn’t right for you even if you can pay off the balance during the promotional period.
Instead, do your best to pay off your personal loan quickly. If you aren’t dealing with a potential early payoff penalty, you can save yourself a ton by making additional payments and working diligently to rid yourself of that debt while leaving it where it is, all while preserving your credit score.
Have you ever used a balance transfer to pay off a personal loan? Do you think it was a mistake? Share your thoughts in the comments below.
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