Using a balance transfer to consolidate your debt
When you have reached the point where your debt seems to be getting out of control and you aren’t gaining any traction with paying down your debt, it is time to consider your debt options.
“Depending on your financial situation, the first place to start to develop a debt repayment strategy is with a DIY debt consolidation. There are different ways to accomplish this; you can seek an installment loan to consolidate your debts from your financial institution. You can also look at doing a balance transfer to consolidate your debts-it really depends on you and your situation,” says Jeff Schwartz, executive director, Consolidated Credit Counseling Services of Canada.
If you are considering a balance transfer to consolidate your debts, there are a few things that you need to know. You also need to have a plan in place to ensure that you pay your debt down effectively. Here are some tips on how to accomplish that.
Why debt consolidation works
Scrambling to make minimum payments on multiple cards is an ineffective way to pay down your debt. Only applying the minimum will take a significant amount of time to actually reduce your debt. That’s because the bulk of a minimum payment is applied to the interest, rather than the actual principal of the debt.
When you consolidate your debts, all of your debts are centralized. That means that you’ve got one balance and one interest rate to deal with. In addition to your debts being consolidated into one, your payment is consolidated into a single payment.
What this accomplishes is that your single payment will get more mileage towards paying down the total debt, which will see your balance go down faster. As your balance shrinks, your interest costs will shrink too (as long as you don’t run the card up again, which we will address further below). This lets you streamline your payments within your budget so that you are getting maximum debt repayment power, by way of a single payment.
Will a balance transfer work for you?
A balance transfer consolidation may not work for everyone. Typically, you would need to have a credit card currently that has enough room on it to consolidate your other balances. Alternatively, you could apply for a new card to consolidate all of your balances on one.
It also only makes sense if you are able to consolidate your debts for the same or lower interest rate. If doing a balance transfer means your interest costs are going to go up, it may not be the right move.
Tips for doing a balance transfer
Given that a balance transfer is becoming a very popular DIY debt consolidation option, a number of new cards have emerged over the last years, promoting themselves as “balance transfer products”, usually with lower interest rates.
A few words of caution here though: these promotional interest rates are usually for a limited time period. That means if you aren’t aware of when this time period expires, you could be on the hook for substantially more. If your interest rates go up significantly, that means less of your payment would be going towards the debt principal, and you may be in similar debt trouble to when you were making minimum payments on multiple cards.
Similarly, doing a balance transfer may involve a fee. Make sure that you are clear on that point.
“As with any credit product, make sure you read the fine print fully and ask questions if you aren’t clear on something. Also, do the math to make sure that the product in question really makes sense given your financial situation and your financial goals,” says Schwartz.
How to do a balance transfer
Once you’ve identified the product that you are going to use, make arrangements to do a balance transfer for consolidation. You can generally do this directly through the financial institution (i.e. through customer service). Provide them with the information regarding your other debts and they will assist you to consolidate.
Once that is done, determine how much you can afford to put down on this debt every month and stick to your plan. It’s more effective for your budgeting to set up a specific payment every month, rather than the required payment for your card. This payment will change as the balance goes down, whereas if you have a set payment based on what you can afford, you will consistently be chopping away at the debt.
How to stay out of debt moving forward
One of the challenges with doing debt consolidation on a credit card on your own is that you may still have multiple cards open. Also, since the card you are using for consolidation is revolving credit (i.e. you can charge it back up to the limit after you pay it down) there is always the risk of creating new debt problems for yourself.
Avoid this by setting up a strict budget and only use credit as part of your overall strategy. Go down to a single card and only use for planned purchases that you are able to pay off each month.
Even when the balance transfer consolidation is paid off, continue to live within the budget that you’ve laid out. You can use the money that you were putting down on the consolidated debts for savings or for other financial goals.
Also, consider how you got to the point of requiring a balance transfer in the first place. Chances are that you were using credit to spend beyond your means. It’s no good to pay down debt only to continue to “buy-now-and-pay-later”. You’ve got to fundamentally change your attitude towards spending and saving.