Lower interest rates are generally better when you are trying to pay off debt. If you are trying to pay off debt in an effort to qualify for a mortgage to buy a home then you may need to approach this method of getting out of debt with some caution.
Taking advantage of a balance-transfer offer is a great way to minimize interest payments to credit card companies and a great way to pay down your balances. However, using this method can wallop your credit scores in a number of ways if you are not careful.
Credit Scores May Go Down With New Credit And Balance Transfers
You may initially get an unpleasant surprise with your credit scores if you’re not aware that your scores could go down after you open new lower interest rate credit cards and transfer your balances.
Opening a credit card account to take advantage of the low interest rate offer can ding your scores by 5 points or so. Transferring your credit card balance to a card with a lower limit can hurt your scores, as can consolidating debt.
The FICO model is heavily influenced by your "credit utilization ratio," the portion of your available credit limit you're actually using. The formula likes to see a wide gap between your balances and your limits. Transferring a balance from a high-limit card to a lower-limit card makes it look like you're closer to maxing out that second card. And the scores can react negatively.
The FICO formula would rather see $1,000 balances on five cards than a $5,000 balance on one card.
If you are going to use balance transfers as a way to get out of debt and you are worried about what might happen to your credit scores you may want to pay attention to some of the following suggestions. You may also want to pay attention to these suggestions if you planning on applying for a mortgage in the near future. Transferring money around on credit cards as I already mentioned can tank your scores.
Do's And Don'ts Of Credit Card Transfers
- Do not open new credit accounts prior to three months of applying for a mortgage
- Only open one credit card at a time
- Do not close out older credit card accounts if you are transferring debt from them.
Further damage to your scores is created by closing the card from which you transferred the balance. Closing the old account trims the amount of available credit that's used in the credit-scoring formula. Closing old credit cards also erases your credit history as well. Approximately 15% of your credit score is determined by your credit history. So you do not want to cancel the credit card that you made a transfer from.
- When you transfer to a new card do not exceed 50% of its limit and if at all possible stay under 30%
- Do not use your cards for cash advances if at all possible – cash advances in almost all cases get charged some of the highest interest rates in the credit card industry
- When you open a new 0% balance transfer card, make sure you read the fine print on making new charges on the card – often these charges are subject to higher interest rates than the balance transfer
- By all means, don’t miss a payment with your balance transfer – you will lose your low interest rates and defeat your purpose for transfer to the new card
- Don’t miss a payment on any other credit accounts either; the Universal Default Clause could get you in this case. The Universal Default Clause is pretty standard with many credit cards and it basically says that you if you miss a payment with any other credit account then the credit card company has the right to change the terms of your credit account with them. Doesn’t seem fair, but it is a common policy and problems for many credit card holders.
Credit Card Scores Will Bounce Back
The good news with new credit and money transfers is that as long as you maintain good credit history and you continue to pay down your debt your credit scores will bounce back. Time can be on your side if you are not in a hurry to get a mortgage for a new home or to refinance. If you can wait it out then rearranging your credit to lower interest rate cards can be a great way to get out of debt.
The bottom line with this method of getting out of debt – be careful, don’t miss payments, and don’t close accounts. If applying for a mortgage, or considering getting a mortgage, check with your loan officer before you start applying for credit card accounts and transferring money around – you could lose your opportunity to get your mortgage with changes to your credit scores. If your scores do go down, don’t worry they should rebound.
If you want more information on your credit scores and credit card balance transfers to lower interest rate credit cards please ask EdGAR.
