Pankaj Mathpal
Balance transfer refers to the process of transferring the outstanding dues from one credit card to another one. This is kind of refinancing and Banks frequently give such offers to acquire clients. Rate of interest offered by the new bank is lower than the interest you pay on your existing card. The offer may be tempting but it may not be always as good as it sounds because the lower interest rate is only applicable for the limited period.
You can save some moneyWhether doing a balance transfer makes sense or not depends a lot on the current interest rate that you are paying and the promotional interest rate being offered. Suppose you have an outstanding balance on Credit card A of Rs 50,000 at a rate of interest of 3.4% per month. Card B offers you a balance transfer for 6 months at a promotional interest rate on 1.79 % per month for 6 months with no processing fees. Assuming you pay off the entire balance during the promotional period you are like to save Rs 3316 as interest charges (Including Service Tax). All This other details remaining the same if the promotional interest rate on card B if 0.99% per month the amount of savings will be Rs 4,930.
Should you really opt for it ?One should be careful about doing a balance transfer. If balance transfer is being done with the intention of paying off the full balance during the promotional interest rate period then it makes sense to go ahead with the balance transfer. However reality can be different. Many opt for a balance transfer expecting less repayment pressure but end up in more debt than they started off with. This happens primarily due to lack of discipline to pay off outstanding in time. Credit Card companies know this and that is the reason they offer a promotional interest rate for a limited time. They are confident that very few people will be able to pay off their entire debt during the promotional period and they can start charging exorbitant interest rates ones the promotional rate is over.
Things to be careful offAny fresh purchases made on credit card after doing a balance transfer does not enjoy any interest free period. Interest will be charged from the very day the purchase is made. No fresh purchases should be made on a credit card till the entire amount is paid off.
Credit cards often charge a onetime processing fee for doing a balance transfer. This may look like a small amount but it will quickly eliminate any savings that you might be making by doing the balance transfer. Continuing with our previous example if credit card B charges a processing fee of 1.99% it comes to Rs 1118 ( Including service tax) on outstanding amount of Rs. 50,000 . The effective savings for promotional interest rate of 1.79% and 0.99% per month will be Rs. 2,198 and Rs.3812 respectively.
Furthermore while calculating interest charges we sometime forget to account for service tax that is applicable on interest charges .This currently stands at 12.36%. High interest rates applicable on credit cards also mean high service tax payable.
Credit ScoreOne of the parameters for calculating credit score is the percentage of total debt to the total credit line available. Since balance transfer involves moving the outstanding balance from one card to another it does not have any impact on the credit score. However, carrying a large revolving debt has a major impact on the overall credit score.
ConclusionBalance transfers do offer some savings from interest charges but it may not be as substantial as it’s made out to be. Either way if one is unable to pay the entire balance due on their credit card by the end of the month they may be living beyond their means. This is a warning sign that all is not well and it may be wise to stop and make amends. Although balance transfers provide some relief from interest charges it is not be mistaken as a silver bullet to rectify ones problem about managing debt. Let’s not forget that credit card debt is the number one reason for people to fall in debt.
Optima Money managers is a financial planning & Wealth Management Company. Author is a Certified Financial Planner and can be reached at www.optimamoney.com
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