Will My Balance Transfer Affect My Credit Score?
There are times when transferring a balance from one credit card to another will save you money. However, saving on interest and fees is not the only consideration to take into account. Transferring a balance can also have an impact on your credit score, which is important to keep in mind, especially if you plan on making a large purchase, such as a home or car, in the near future.
What factors influence a credit score?
Before we look at the positive and negative impacts a balance transfer could have on your credit, it is important to understand what factors make up your credit score. This is a three-digit number ranging from 300 to 850 that determines whether you will be approved for a loan and what sort of interest rates you will be granted.
The exact formula for determining your credit score is unknown (and could vary), but we do know the most important factors, which are:
- Payment history (35%)
- Credit Utilization (30%)
- Length of credit history (15%)
- New Credit (10%)
- Credit Mix (10%)
The three factors most impacted by a balance transfer are credit utilization, length of credit history, and new credit.
When will a balance transfer have a positive impact?
Transferring a balance can have a positive impact on your credit, as it may help you lower your credit utilization. To maximize your credit score, you want to use no more than 30% of your available credit. If you are using more than this on your current cards, opening a new card and transferring the balances can help you improve your score.
For example, let’s say you currently have two credit cards, one has a credit limit of $5,000 and the other has a limit of $6,000. In total, you have $5,000 in debt, which means you are using 45% of your available credit. If you open a new credit card with a limit of $6,000, your credit utilization will drop to 29%. Since you have dropped your credit utilization below 30%, your credit score will likely increase.
When will it have a negative impact?
Before you jump on that 0% introductory offer, though, it is important to know that a balance transfer could also negatively impact your score. First, when you apply for the new card, a hard inquiry will appear on your credit report. These are factored into your score for a year, and can decrease your score—particularly if you have several inquiries in a short period of time.
The other issue is that opening a new account will impact your length of credit. When determining the length of credit history, FICO averages the age of all of your credit cards. Continuing with the example above, if your two credit cards have both been open for five years, and you open a new credit card, this will drop your length of credit history from five years to about three years, which can negatively impact your credit.
Since credit utilization accounts for 30% of your credit score, and new credit and length of credit account for 25% of your credit score (combined), opening a new credit card and transferring your balance will likely have a very slight positive net impact on your credit.
There are other ways transferring a balance can positively impact you. If you are transferring your balances to a card with a lower interest rate, you can save money on interest and pay off your debt faster. This will increase your credit score and greatly improve your financial situation.
Finally, remember that most credit card issuers charge a fee for transferring the balance from one card to another. Typically, this fee is 3% of the amount transferred. It is important for you to mathematically calculate whether the money you save on interest charges outweighs the up-front balance transfer fee.