Monday, February 2, 2009

How Balance Transfers Affect Your Credit Score

Transferring balances with high interest rates to a credit card with a lower interest rate (or a 0% interest balance transfer offer) is a great way to pay your debt off faster and save money in the process. It's not as cut and dry as transferring the money from one place to another though, there are some other considerations to work out before you rush into the next balance transfer offer you qualify for: primarily, how does a balance transfer affect your credit score?

Balance Transfers and Credit Scores – What's the Connection?

Due to the formula used to calculate an individual's credit score, moving money from one credit card to another can actually cause some negative issues with your credit score that you may not have even realized.

Credit scores are calculated with a top-secret formula, but we do know how much weight each component of our credit carries in the calculation:

  • Payment History – 35%
  • Outstanding Debt – 30%
  • Established Credit – 15%
  • New Credit – 10%
  • Type of Credit - 10%

  • As you can see, the two biggest factors contributing to your credit score calculation involve how well you make your payments and how much debt you currently have. When considering balance transfers and how it will affect your credit score, first you should realize that most people mistakenly close out the old credit card once the balance has been moved to the new card – this is bad because it lowers the average age of your accounts and this accounts for 15% of your credit score. If most of your credit is recent, and you close your old account(s) as you transfer balances, you've suddenly decreased the average length of time you've had credit and your credit score will decrease as a result.

    In addition, if you close out your old credit card account after transferring the balance, you've lowered your debt to credit ratio, which accounts for a whopping 30% of your credit score. Closing the account gives you less credit available to you, which means you are suddenly using more of your available credit even though you haven't spent any more money.

    It's also true that opening a credit card account – like the one you want to transfer your higher interest balances to, will result in a lower credit score. New accounts make up 10% of your FICO credit score, so it's possible that opening the new account will take a hit on your account, but since it's only 10% of your overall score calculation, it shouldn't be as big of a factor as closing out the older account.

    If you transfer a balance to a new card, and leave the old card open – it will actually appear as if you owe less money because you have a higher available credit amount. You may experience a bit of a credit score increase from this which can counteract the decrease from opening a new account.

    Goals for Balance Transfers

    Your goal is to have less than 30% of your available credit (all cards included) utilized. You should always look to transfer balances to cards that give you the best rates, and leave your old accounts open. In the meantime, don't charge any more money until your total balance is well below the 30% utilization, and you'll soon see your credit score affected positively for these responsible financial decisions.

    In order to get a better understanding of where you stand with your credit score, don't forget you're entitled to a free credit report from each of the three credit reporting agencies annually. With the report, you can see how much credit you're using, and whether or not looking for a new balance transfer offer might help you raise your score and save money on interest.

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