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How Do Balance Transfers Affect Your Credit?

Ben Luthi

A balance transfer credit card can be an excellent tool to pay off high-interest debt. But if you're not careful, you could pile up more debt instead of paying it off and drag down your credit score.

A balance transfer affects several variables that influence your credit score, for better or for worse. Carefully consider the pros and cons before you move debt to a balance transfer card with an interest-free or low-interest period.

How a Balance Transfer Can Affect Your Credit Score

A balance transfer could influence three of the five factors that determine your credit score, including:

-- New credit

-- Length of credit history

-- Credit utilization rate, or how much of your available credit you use

These factors could be affected at each step of the balance transfer process. The process involves:

Applying for a balance transfer credit card. Although you can request a balance transfer on most credit cards, including ones you have open, it's generally best to use a new balance transfer credit card. These cards offer consumers an introductory zero percent APR on balance transfers -- and sometimes new purchases -- for a set period, often more than a year.

[Read: Best Balance Transfer Credit Cards.]

When you apply for a balance transfer credit card, the credit card company runs a hard credit check. For most people, this hard inquiry will knock off up to five points from their FICO credit score.

If you are approved for the first balance transfer card you apply for, you likely don't need to worry about this hard inquiry. But the more hard inquiries you have when applying for a card, the more your score could drop. If you want to avoid this scenario, check your credit score to make sure you have a good chance of approval. Or look for a preapproval option, which can tell you whether you're likely to be approved using only a soft inquiry that doesn't affect your credit rating.

Most balance transfer credit cards require good or excellent credit, which means a credit score of 670 or higher. If your score isn't quite there yet, work on improving it before you apply. And if you receive a preapproved card offer in the mail, think about applying for that instead of an offer you find online, as long as the offer is as good as or better than other cards you're considering.

"When credit card companies target you and send you an offer through the mail," says James Garvey, CEO and co-founder of Self Lender, which offers credit-builder loans, "the likelihood that you'll be accepted when you've been preapproved is much higher." That doesn't mean it's a guarantee, though.

Opening the new account. Once the credit card issuer approves your application and opens an account in your name, the average age of your credit accounts changes, which influences your length of credit history. For example, if you have two credit cards -- one 10 years old and the other 4 -- the average age of your accounts is 7. If you open a new card, the average age will drop to 4.66 years.

Depending on the rest of your credit profile, that decrease could hurt your credit score. But if you've been using credit for a long time and have an otherwise stellar history, it likely won't tarnish your score as much as if you were fairly new to credit.

Making the transfer. The balance transfer itself doesn't influence your credit score at all. But if the credit limit on your new balance transfer credit card is lower than on your original card, processing the request could result in a higher credit utilization rate, also called a credit utilization ratio. Keep in mind that a 3 to 5 percent balance transfer fee usually applies, which can add to your balance.

Your credit utilization ratio is calculated by dividing your card balance by its credit limit. For example, if you have a $5,000 balance on a card with a $10,000 limit and transfer it to a card with a $6,000 limit, your utilization rate will increase from 50 to 83 percent.

While both rates can hurt your credit score -- the ideal is less than 30 percent of your total available credit -- the higher one will do more damage. "FICO uses very sophisticated algorithms to determine your likelihood of defaulting," Garvey says, and a high utilization rate signals that you may have a tough time making all your payments.

[Read: Best Credit Cards Without Balance Transfer Fees.]

The good news is that your utilization rate will decrease as you pay down your debt, which can go faster if you're not paying interest. So if you don't plan to borrow soon, a temporarily lower score might not affect you much.

But if you can't afford a lower credit score right now, transfer just a portion of your debt to the new card to keep the utilization rate low. As you pay down the balance, you may be able to transfer more. After a few months of on-time payments, consider asking the issuer for a credit line increase.

Closing the old account. After you've requested the balance transfer, you may consider closing your old account. That's typically a good idea if you might be tempted to rack up more debt, but canceling the account can affect the length of your credit history and your credit score.

Once you close the account, the card no longer helps boost your average age of accounts as it sits in your wallet. That said, a closed account that was paid as agreed will remain on your credit report for up to 10 years, so you won't lose the account's age entirely for a while.

Closing your account also can affect your credit score because you lose the card's available credit. Say you have three credit card accounts, including your new balance transfer card:

-- Card A has a $5,000 balance, with a $10,000 credit limit.

-- Card B has a $500 balance, with a $5,000 credit limit.

-- Card C has a zero-dollar balance, with a $6,000 credit limit.

As it stands, your credit utilization ratio across all cards is roughly 26 percent. But if you move the balance from Card A to Card C -- assuming no balance transfer fee, for simplicity's sake -- and close the first card, your aggregate credit utilization jumps to 50 percent.

The higher your credit utilization across all your cards, the more your credit score could drop. There's no telling how much, though, says Freddie Huynh, vice president of credit risk at Freedom Financial Network, because the credit score calculation is complex. "It can be very hard to provide a blanket statement on how a consumer's score is going to be impacted," he adds.

Consider the advantages and disadvantages of keeping the card open, including the cost, Garvey says. For example, does the card have an annual fee? Or, will you end up taking on more debt? If so, Garvey says to take the credit hit and save money.

[Read: Best Zero Percent APR Credit Cards.]

Using a Balance Transfer to Boost Your Credit

Balance transfers can either hurt or help your credit. If you can qualify for one, a balance transfer card could save on interest to pay off debt faster. Here are a few tips to get you started:

Develop a repayment plan. A balance transfer may not make much of a difference if you are adding new debt to your card and still have a large balance when the card's promotional rate ends. "If you are considering a balance transfer because you have been living outside your means," Huynh says, "balance transfers can give a false sense of progress. Doing a balance transfer means making a real commitment to get out of debt." Set up a plan to pay down the debt as quickly as possible, ideally, before the promotion expires. Even if you fall short of your goal, prioritizing debt repayment will lower your credit utilization rate more quickly and help you improve your credit in general.

Stop using credit while you're paying down your debt. If you're using other credit cards while paying off your balance transfer, it can feel like you're taking two steps forward and one step back. Switch to cash or your debit card, at least until you're debt-free.

Pay your bill on time each month. Your payment history is the most important factor in your FICO credit score, making up 35 percent of the score's calculation. Consequently, making at least the minimum payment on time each month is crucial. To avoid forgetting, consider setting up automatic monthly payments. You can choose the amount or pay just the minimum. If you make a mistake and forget a payment, don't fret. The payment won't show up on your credit report as late until it has been delinquent for 30 days. You may, however, be on the hook for a late payment fee, usually about $36. Get caught up as quickly as possible to maintain a solid payment history on the account.

Balance Transfer Alternatives

A balance transfer can help you get out of debt, but it's not the only answer. Other options may be a better fit. For example, if you need a more structured debt repayment plan, you might want to explore a consolidation loan with a set repayment term rather than a new balance transfer credit card.

Perhaps the balance transfer fee doesn't allow you to save much money. The cards charge these fees to process the transaction. "Calculate the balance transfer fee, and make sure it doesn't outweigh the interest savings gained from the transfer," Huynh says.

Be sure to compare balance transfer credit cards before you apply for one. Each card has different terms, benefits and features, and one may be better for your situation than another.

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