Credit Balance Transfer - Credit Card 101
Here at Credit Balance Transfer we appreciate that interest rates, APR's and financial statements aren't everyone's strong point. On this page we're going to outline some basics from 'what a credit card is' right through to which deal is best for your own credit balance transfer needs.
What Is A Credit Card And What Is It For?
Basically a credit card allows you to make purchases (of products or services) without requiring the funds to pay for them immediately. When paying by cash, bankers draft or debit card you need the funds for your purchase either to hand or in your bank account at the time of purchase. When paying by personal cheque, although it generally takes a few days to clear, there's no implied credit period. Thus you shouldn't sign a personal cheque without the funds to cover it. By comparison to the other examples, a credit card permits you to purchase something without having the funds at that time to pay for it.
How Much Credit Do You Get?
The credit limit (how much you can spend) assigned to you is assessed by your credit score. If you have a good credit score you should receive a high credit limit. However, if you've defaulted on loan repayments, catalogue repayments, mortgage repayments or simply fail to pay your bills on time it's likely that you'll have a low credit score. This will result in you getting a lower credit limit. Basically if this is the case your credit history tells the credit company that you're a high risk and that they may not get their money back from you.
What Does It Cost To Use A Credit Card?
Generally speaking, assuming the credit card has no annual fee (which is now the norm) it wont cost anything to use unless you fail to pay off the entire balance by the due date. So if in January you run up a £240 bill on your card, provided you pay off the £240 in full on the very first statement you receive - there will be no charges. You just pay back the £240 that you borrowed on credit.
How Does Interest Work?
Interest is very simple. The interest rate is represented as a percentage (%). A percentage is merely so many parts in a hundred. So 6% means six parts per hundred. When we use percentages with money 6% would mean £6 per £100.
Let's say you have a savings account with a bank and they pay you 4% on your savings. That means that each year they give you £4 for every £100 you've had with them for the year.
Let's say you have £500 in your savings account and the bank have just paid you your 4% interest for the year. Remember that they give you £4 for every £100 you have saved. You have 5 lots of £100 (in your £500) so that means they give you 5 lots of £4 in interest. 5 x £4 = £20 Interest.
Sometimes you may not have a round figure like £500 to work with, so lets try an example with a more awkward number. Let's say you have £452.35 in your account and the yearly interest rate is still 4%. Another way of writing 4%, is 4 parts per hundred or 4 divided by 100 (4/100) or 0.04
Don't worry if you didn't understand decimals at school - this is easy when presented this way. Here's an easy system to learn what decimal is equal to what percentage:
100% = 1.00, 99% =0.99, 98% = 0.98, 97% = 0.97 and so on to... 12% = 0.12, 11% = 0.11, 10% = 0.10, 9% = 0.09, 8% = 0.08
OK, back to the example. We have £452.35 x 4% interest. Looking at the above examples we can deduce that 4% is the same as 0.04 so that's what we multiply by. Hence, £452.35 x 0.04 = £18.09 interest for the year.
How Does Compound Interest Work?
Compound interest or 'compounding' refers to interest being added to interest as time goes by. In the above example we started with £452.35 and calculated one years interest at 4%. The interest worked out at £18.09 and would be added to the original amount of £452.35
So at the start of year two we have a balance of £452.35 + £18.09 = £470.44
Let's now move to the end of year two and add our 4% interest. Remember our new balance is £470.44 and we're multiplying by 4% (or 0.04). £470.44 x 0.04 = £18.82 interest for year two. Notice that the interest paid for year two is higher than it was for year one. This is because we are also being paid interest on the money we made in year one.
Let's examine one more year and we'll call it a day. At the start of year three we have £470.44 + £18.82 = £489.26 to invest. The interest rate is still the same at 4% so at the end of year three we can multiply £489.26 x 0.04 = £19.57
Once again we can see we've made more money than year one and also more money than in year two. Our total now stands at £508.83
That is how compound interest works.
Compound Interest On Credit Cards
In the above examples we were using a bank account where YOU were receiving the interest on your money. However, when it comes to credit cards the money belongs to someone else so you pay the interest rather than receive it!
The other difference with credit cards is the frequency with which they compound interest. In our examples you got paid your 4% interest once each year so the compounding took place yearly (annually). However, with credit cards the compounding takes place monthly. That means each month interest is added to interest on the remaining balance.
Here's an example so we can see how this works with some numbers:
Let's say you owe £5,000, the credit card interest rate is 1% per month (12% overall) and we're going to ignore you making any payments just to keep the maths clear. Let's start in January with £5,000 x 0.01 (1%) = £50 interest. In February the starting balance is £5,050 including Januarys interest. Let's calculate the interest £5,050 x 0.01 = £50.50 interest giving a balance of £5,100.50 (notice the interest charges for February are 50p higher than January even though the interest rate is the same for each month at 1%)
In March the starting balance is £5100.50 including January and Februarys interest. Let's calculate the interest for March. £5100.50 x 0.01 = £51.00 interest.
Now take a look at the interest over the three months; January £50.00, February £50.50 and March £51.00. Notice how the compounding of adding interest onto interest puts you further and further into debt. The longer the balance is outstanding the more compounding takes place.
It is this compounding of interest which results in a figure called APR (Annual Percentage Rate). Remember that we are paying 1% each month of the year (1% x 12 months = 12%). However because there is interest being charged on previous interest due to the compounding - the actual yearly rate isn't 12%!
Credit Cards - How Is APR Calculated?
Before we discuss APR and credit cards let's step back for a moment and consider a standard bank loan. If you borrow money from a bank on a loan you'll be presented with two interest rates.
The first interest rate type is nominal APR sometimes called EAR. This would be the interest rate multiplied by the number of payment periods (for example 12 months in the year). So a nominal APR could be 12% (1% per month for 12 months). This interest rate disregards compounding.
The second interest rate is effective APR. This considers the same interest rate and period but takes into consideration the compounding effect of interest upon interest. So in this example it could be (1% per month for 12 months) however when you total up the compounding effect the actual interest rate you'll pay is about 12.68%
If you want to know what you're 'really' going to pay - use the effective APR as a guide.
When it comes to credit cards ALWAYS look at the effective APR!
Credit Cards - Making Savings With 0% Balance Transfers
As we've already discussed how APR (interest) works on credit cards it's easy to see that a lower APR will cost you less money in interest repayments over the long term. It stands to reason that a 15% APR is better than a 19.9% APR. However, the ultimate golden APR is 0%
Now let's discuss how a credit card balance transfer works. Let's say you have a credit card with an outstanding balance of £3,500 and an APR of 23.9% - the interest rate is crippling and will be adding so much to your debt each month that it will take almost a lifetime to pay off.
However, another lender has a 0% Balance Transfer deal on one of their cards for 12 months and you think you'll get approved by them to recieve one of their cards. Let's assume you do get approved and receive your shiny new card. It currently has no debt on it as you've only just received it. However, the new lender says they'll give you 12 months at 0% APR for any existing balances you transfer onto their card.
What you'd do is give them a call and tell them you wish to transfer the £3,500 from your old card (at 23.9% APR) over to theirs at 0% APR. There may be a small charge for this but you need to offset it against your savings. We'll discuss how to calculate that in a moment.
Instead of being charged 23.9% APR interest on your £3,500 over the next year (0.239 x £3,500 = £836.50), you wont be charged any interest at all (£0.00). Now remember we said above that there may be a small charge for the balance transfer? These charges are normally 1.5% to 3% of the amount transferred, but you'll have to look at the new lenders terms to find out their specific rate. Let's say for this example the transfer fee is 2%. So, 0.02 x £3,500 = £70.00
It's quite possible that the £70.00 fee will be added to your balance making it £3,500 + £70.00 = £3,570.00
Now let's compare the potential savings to the cost. We stand to save £836.50 in interest payments over the year and it's cost £70 to put in place. So, £836.50 - £70.00 = £766.50
Therefore the balance transfer has potentially saved you £766.50 over the coming year!
Balance Transfers - What To Watch For
There's probably not much point making a balance transfer unless the rate is 0% APR, the reason being that many lenders do offer this rate. However, if your credit rating is particularly bad you may well have difficulty getting another lender to take on your debt.
The next thing to consider is the duration of the 0% APR offer. If it's only three or four months then it's hardly worth it. Remember that you'll still probably have to pay a transfer fee but your savings will only be on three or four months interest. Ideally you want to go for 12 months or longer for a 0% deal. Some cards now do up to 16 months at 0% with a fee of 3% or less. Significant savings can be made with long duration deals.
One thing commonly overlooked by people transfering their credit card balances is the APR rate AFTER the 0% APR has expired. So if you sign up for 12 months at 0% and transfer your balance... what happens in month thirteen? Well if you didn't check the terms and conditions before you made your balance transfer, you could be in for a nasty shock! Always, always make sure you know what the 'standard rate APR' is for a credit card BEFORE you transfer your balance. Also double check whether the issuer will switch your 0% balance transfer to a higher than standard rate following the introductory period. Some issuers are adding a percentage point or two to their APR for existing balance transfers once the introductory rate has expired. It's not the end of the world, but be aware (in advance) of what you're signing up for over the long term.
Obviously the lower the standard rate APR is, the less interest you'll have to pay. Of course there's always the option of transferring your balance to a 12 month 0% APR deal with another lender once your original deal expires.
Many credit card companys have 'small print' that states if you fail to make a payment on time during an introductory rate period (such as a 0% APR for 12 months), then your account immediately shifts to another rate (possibly standard or worse). So if you miss a payment, on say your second months statement, don't be surprised if you get some sort of fine as well as seeing the APR shoot up on your next statement. The message is - pay your bills on time.
Transferring Balances From More Than One Credit Card
Sometimes you may have several active credit cards, each with a balance you'd like to transfer. For exmaple on card one you may have £600, on card two you have £1,000 and on card three there's £2,500. Let's say you get another credit card with 0% APR for 12 months. In this example we'll assume your new card has a credit limit of £6,000 so it's possible to transfer the balance from each of the other cards (£600 + £1,000 + £2,500 = £4,100). As you can see the amount you wish to transfer is LESS than the new cards maximum limit, thus you can transfer all three balances. Remember that the new lender may charge a transfer fee for EACH of the transfers. However, the amount charged should be the same or only a little more than if you'd transferred the entire amount (£4,100) from one card.
Let's consider a slightly different scenario this time. You still have your three cards with a balance of £600, £1,000 and £2,500 respectively. However this time your new card has a credit limit of only £3,500 - this is where you need to consider your position carefully. You can't transfer all of your outstanding balances onto the new card as you owe £4,100 in total and your balance transfers can only be up to £3,500. To make the best possible decision you need to look at the APR rates of your three existing cards. Let's say your £600 card has an APR of 35%, your £1,000 card has an APR of 19.9% and your £2,500 card has an APR of 16%. As you can see, the £600 card has (by far) the highest interest rate so this balance should be the first one to be transferred to your new card.
It's important to point out here that of all the statements received for the three credit cards, the £600 one will probably have the 'lowest' minimum payment amount. This can be misleading making some people think it's not as urgent as the others whereas in truth the interest rate is around double that of the other two cards! Always get rid of the highest APR's first.
OK, so we've transferred the £600 from highest interest (35% APR) card to the new 0% credit card. This leaves us with £2900 of available transfer space (£3,500 - £600 = £2,900). Next we consider which of the two remaining balances has the highest APR. It seems the card with 19.9% APR and £1,000 balance is next in line for transfer. Let's transfer that one now. This leaves £1,900 of available transfer space (£3,500 - £600 - £1,000 = £1,900).
So now we have £1,900 of 0% transfer space remaining, but we still have a £2,500 balance at 16% APR. It's ok to transfer part of an existing balance so in this case we'll transfer £1,900 of the £2,500 balance from the 16% APR card to the 0% APR card.
So far we've transferred £600 from the 35% APR card, £1,000 from the 19.9% APR card and £1,900 (of the £2,500) from the 16% APR card. Adding these up we find we've gone right up to the £3,500 limit of our new card (£600 + £1,000 + £1,900 = £3,500).
Now we have a 'full' new card containing £3,500 at 0% APR for 12 months and we also have £600 left on the lowest 16% APR card. You would need to prioritise clearing the £600 debt from the 16% APR card FIRST as this debt will grow each month as the interest is compounded. So long as you make minimum payments on the 0% APR account it wont get any bigger for at least a year, although this would be an ideal opportunity to pay off your debt.