Balance transfer credit cards explained

 

Introduction to Balance Transfer Cards - Video

Balance transfer credit cards were first introduced to the UK in the early 1990's by US issuers keen to gain foothold in the UK market. The cards were instantly popular as they had been in America, where smaller US issuers had developed the format to incentivise switching and help challenge the traditional banking establishment.

Given the popularity of balance transfer products, UK credit card issuers quickly adopted the product format themselves, enabling them to compete directly with the new US entrants.

Balance transfer cards have remained amongst the most popular types of UK credit cards ever since. And although the balance transfer format has developed, such that some are now available with a host of other features, customers remain drawn to them for their perceived primary benefit - their ability to save people money.

How do balance transfers work?

Balance transfer products are available from numerous UK banks and issuers and, although there are differences between specific products and their mechanics, they all broadly work in the same manner and offer the same primary benefit. They help people save money by reducing the interest they are required to pay on their debts.

People who have accumulated debts on their credit card(s) are offered the ability to transfer their balances (debt) from an existing credit card to a balance transfer card at a reduced introductory interest rate. In the vast majority of cases the interest rate charged is 0% for the introductory period (after which the interest rate reverts back to the product's standard APR).

By reducing the monthly interest payable on their balance (which many issuers require to be paid as part of the minimum monthly repayment), balance transfer customers are often able to reduce the cost of their monthly repayments. Additionally, those minimum monthly repayments they do make are directly used to reduce the principle amount that they have borrowed, rather than being used to service interest payments, and the interest-on-interest effect that compounding has. This means customers who balance transfer can pay off their credit cards debt considerably quicker than they might have done had they remained with their original card issuer.

What to consider before applying for a balance transfer product

Although every card is different and each has its own unique small print (which should also be examined to ensure suitability), there are six important elements that consumers should consider before applying for a balance transfer product.

Product Eligibility

Most credit card issuers are explicit about the eligibility for their products, and although each issuer and product will have specific criteria, they tend to be focused on the following elements:

Where an applicant does not meet these criteria, an application for a product (which they cannot get) can only be detrimental to their overall credit score.

Balance Transfer Period

The introductory period is the period of time for which the balance transfer rate applies. They vary widely from issuer to issuer and their individual credit card products, but are usually measured in terms of a set number of months (although deals are occasionally available that are fixed to a particular end date). Applicants should be aware that the balance transfer period is typically started at the point they are accepted for a product, rather than the point at which a balance is transferred.

Traditionally, the introductory period was considered the most important element when comparing balance transfer credit cards, but increased competition around other elements of products have made impartial comparison a more difficult process. The balance transfer period remains an important consideration, but it should now be assessed as part of the overall product, rather than the as determining factor behind products desirability.

Balance Transfer Fees

Although balance transfer cards typically incur no interest on balances transferred to them, most require customers to pay a fee (balance transfer fee) for them to undertake the transfer. These fees are charged at the time consumers undertake a transfer, and tend to be added to the overall account balance. This gives customers the advantage of not needing to find additional money to undertake a transfer, but it can be disadvantageous to customers who miss minimum repayments and are returned to their card's standard APR, as they then pay interest on fees for a service they may have gained very little benefit from.

Transfer fees can vary considerably between different issuers and products, and given that they are typically the only charges associated with transferring balances (assuming you make your minimum payments on time and your card is not one of the few UK credit cards which charges consumers an annual fee), it is worth understanding what you'll pay and how many months at a given interest rate a particular fee will enable you to access.

It should be remembered that the balance transfer fees consumers see advertised are usually only applicable for an introductory period (normally around 90 days). Thereafter, they revert to a different (often considerably higher) rate.

Balance Transfer Rate

Although many people associate balance transfers exclusively with 0% introductory periods, other low interest rates (sometimes marketed as 'life of balance' rates, although they are still theoretically 'variable') are available and can be better suited than 0% deals, depending on individual circumstance.

These rates are often particularly interesting to individuals who are less organised, and are therefore keen to get a card with a low ongoing rate rather than remembering to switch their credit card (and transfer their balance) every few years.

Representative APR

Although many people overlook the standard representative APR for a given product, choosing purely on the introductory offer, the APR is something that should be seriously considered amongst the mix of other attributes.

It should be noted that up to half of consumers do not pay off their balance during the introductory period and are therefore (unless they are careful to switch again) subject to their cards 'go-to' rate of interest (a rate that many will have overlooked at the point they applied for the card).

Credit Score

An individual's credit score is increasingly important for accessing the best credit cards. Changes (detailed below) which have come into effect in the past few years have magnified the importance of a good credit score, and the repercussions for those who do not have one.

Getting the best balance transfer card

Getting the best balance transfer offer was once a relatively easy process. Card issuers competed aggressively for business on the basis of balance transfer duration, but the transfer fee was broadly the same regardless of product. Customers looking for the 'best' deal could simply navigate to the top of balance transfer comparison tables and select the highest ranked product (or highest ranked product they were permitted to apply for).

However, as balance transfer durations have ballooned over the past few years, issuers have sought to foster increased interest in their products by competing directly on the fees required to transfer. Initially, this saw issuers reduce transfer fees by modest amounts, but as savvier and more financially literate consumers quickly realised that they could make a valuable trade-off between the 0% duration and the transfer fees payable to reduce the overall cost of their transfer, the popularity of the products grew. These inspired the launch of numerous products competing primarily on balance transfer fee, to the point that we now see a number of balance transfer cards offering 0% transfer fees.

This fragmentation of the market has meant that getting the best transfer deal is not the simple and exact science it once was. Customers must consider, amongst other things, how long they need to clear their balance, which issuer their existing balance is held with and how good their credit score is.

An individual's credit score has become an increasingly important consideration since the Consumer Credit Directive 2010 harmonised EU credit legislation and changed the way products could be promoted in the UK. Prior to the CCD UK, issuers operated within the framework provided by the Consumer Credit Act 1974, which stipulated that the products they advertise had to be 'typical' of the contracts they entered into with consumers. Typical was defined as been 66% of contracts (whilst 34% could be offered a different product).

After the UK implemented the CCD (Consumer Credit Directive) on 1st February 2011, the threshold for the contracts changed to being simply 'representative'. On this basis issuers legally had to offer only the advertised rate of 51% to the individuals they entered into contracts with. In effect, credit card issuers could be far more selective regarding the customers they accepted. It also meant that since 49% needn't be offered the headline rate, they could place increased emphasis on their 'down-sell' propositions - those products that offered a lower introductory period and a higher rate of interest to those applicants who were not deemed to be creditworthy enough to be accepted for the advertised rate. In reality, not all UK issuers offer down-sell products, but the fact that they are available, and issuers can use them to increase the profitability of products, means that all headline pricing reflects their existence and the increases acceptance threshold (or credit score requirement) for all applicants.

How do balance transfers affect your credit rating?

Balance transfer cards often have both a positive and negative effect on an individual's credit rating, depending on their particular circumstances. Often accepted applicants notice that their credit score initially declines as they have taken out additional credit, which is equally true of other credit products. However, depending on how the card is used, credit scores can quickly regain lost ground and, in many instances, settle at a higher credit than the individual originally had. This is partly because balance transfer cards enable people to more quickly clear their balances, which is a good sign in and of itself. But it is also due to one ratio that helps inform an individual's credit score.

The ratio of available credit to total balance (or utilisation rate) is an important marker for credit reference agencies. Where this ratio is low is it considered to be a sign of responsible credit management and rewarded accordingly (with an improved credit score).

Assuming an individual does not increase their overall debt burden after obtaining a balance transfer card, their total available credit will increase and therefore the ratio between their balance and available credit will reduce.

Existing Customer Balance Transfers

Most credit card issuers will not accept transfers to another of their products. This is principally because a 0% proposition that lasted indefinitely would be unsustainable - it would cost the issuer more to borrow the money than the return they would see on it.

This does not mean that issuers do not offer their existing customers attractive deals to encourage them not to switch, but they are unlikely to be the highline grabbing deals available at the top of balance transfer tables.

Although many people understand that they cannot switch one card with "Brand X" to another "Brand Z" card, what is perhaps least well understood is that issuers also prohibit transfers within their wider group of brands. For example, the Halifax and Bank of Scotland brands are both owned by Lloyds Banking Group, therefore one could not transfer a balance from a Halifax credit card to a Bank of Scotland card. Equally, one could not transfer a balance from the Hilton HHonors™ card to a Barclaycard branded card, as they are both issued by Barclaycard.