Beware of bad balance transfers

by Cliff D'Arcy on 06 August 2009  |  2 comments
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Using a 0% balance transfer to avoid interest on your credit card debts is a great idea. However, watch out for these drawbacks!

Here's a shocking fact for you: roughly two out of three credit cards in the Eurozone were issued in the UK!

We are the boldest borrowers in Europe

As a result of our 'plasticmania', we Brits owe £54.4 billion on credit and store cards, plus a further £178 billion in other non-mortgage debt. This debt (amounting to £4,850 per adult) puts us among the most heavily burdened borrowers in the world.

Our Continental cousins -- especially those in the two biggest economies, Germany and France -- are much more cautious when it comes to credit. Rather than spend on credit cards, our thrifty neighbours prefer to use debit cards and savings.

The crippling cost of credit

The big problem with debt is that it bears interest. In other words, it costs money to borrow money. For example, a typical credit card charges an interest rate of 18.1% APR on purchases. For cash withdrawals, interest rates can reach a whopping 50% APR!

Hence, if you're paying interest on your card debts, your best option is to become a 'rate tart' by taking advantage of 0% balance transfers. According to lovemoney.com's search engine, 72 different credit cards offer extended interest-free periods on transferred debts. So, by shifting your existing balances to a new 0% card, you can enjoy a break from interest lasting five to 16 months.

Four 0% transfer tricks

Warning: before you get into the 0% game, watch out for these four snags:

1. No more loose lending

Gone are the days when lenders would offer large credit limits to anyone with a pulse. Any black marks in your credit history (such as late or missed payments) will count against you. Indeed, one leading card issuer rejects half of all new applications for credit.

2. Penalty fines

If you pay late or miss a payment, many card issuers will cancel your 0% deal and charge interest on your balance transfer at the purchase rate. So, set up a direct debit or standing order for at least your minimum monthly repayment - preferably more as you will pay your debt off far quicker this way.

3. Transfer fees

Alas, interest-free credit isn't an entirely free lunch. In order to make money from these deals, all 0% cards charge fees for transfers. (The one exception to this rule is Northern Bank in Northern Ireland, which has a no-fee 0% deal for five months.) Most 0% deals have a 3% transfer fee, so shifting a debt of say, £2,500 will immediately add a charge of £75 to your new balance.

4. Short 0% periods

Beware of shorter 0% deals, as these can provide poor value for money. For example, a 0% transfer for 12 months charging a fee of 3% is much better than one for just six months with the same 3% fee.

0% transfer fees can be rip-offs!

While 0% deals may be interest-free, some charge unacceptably high fees. The table below shows the 'true cost' of 0% deals lasting six, nine and 12 months:

Annual equivalent interest rates (AERs) for a 3% transfer fee

(assumes that each transfer is fully repaid in equal instalments by the end of the 0% deal)

As you can see, a 3% fee spread over 12 months is equal to a yearly interest rate of 5.6%. The Bank of England base rate is at a 315-year low of 0.5%. This suggests that a 3% fee makes even a 12-month 0% deal profitable. Over six months, a 3% fee comes to 10.7% AER, which makes this deal lucrative for lenders and, therefore, bad for borrowers.

Of course, the higher the transfer fee and the shorter the 0% period, the worse a 0% deal is. For example, I recently received a mailing from one card issuer offering me a 0% transfer for six months with a fee of 4%. This works out to be an effective interest rate of 14.5% a year, so I politely declined!

(By the way, don't use a 0% balance transfer card to rack up yet more debt. Never take one shopping, as almost all 0% transfer cards charge high rates of interest on purchases and you're likely to be hit by negative payment hierarchy. Instead, store your card somewhere secure and put a reminder in your diary/calendar of when your 0% deal runs out. And if you need to do some spending use a separate 0% purchases card.)

Playing the long game

If you can't be bothered to flip your debts from one card to another every year or so, then a lifetime balance transfer may be a better bet. Instead of leaping from one 0% deal to the next (and paying fees each time), you pay a low, fixed interest rate until your debt is repaid. Here are my two favourite cards in this category, neither of which charges transfer fees for applications via lovemoney.com:

Best Buy lifetime balance transfers

So whatever you do, make sure you don't get caught out by your credit card! Good luck!

More: 0% transfers could be doomed| Fifteen cracking credit cards

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