At one time or another most of us find ourselves juggling our debt. Whether faced with unexpected expenses or periods of unemployment, credit card debt can sneak up on you. The money-saving incentive to transfer debt to a no or low interest credit card is obvious. But how will this affect your credit score? The answer (as with most financial questions) is: it depends. Opening a new line of credit requires a “hard inquiry” on your credit report and lowers your credit score slightly. This is a small concern if you are only opening a single line of credit.
Transferring your credit card debt can help improve your credit score when the transfer results in a lower credit utilization ratio. This ratio, which comprises 30% of your credit score, is calculated by comparing the amount of available credit you have (both overall and per card) to the amount of credit you have used. Ideally this ration should be less than 30%. For example, let’s suppose you have two credit cards, both with a $5,000 limit and you have a $3,000 balance on one card, and a $1,500 balance on the other. Your total available credit is $10,000. Your total debt is 4,500. This would make your overall credit utilization ratio 45% ($4,500/10,000 = 0.45 move the decimal point over two spaces to the right to get your percentage). This is a bit high. Assuming the new no/low interest credit card also has a $5,000 limit, and you wanted to lower this ratio, it would make sense to transfer half of the $3,000 balance ($1,500) to the new card. This strategy would lower both your overall, and per card, credit utilization ratio.
Another option is to transfer both balances to the new card. If you plan to then pay off the new card within the window of the low or no interest offer (usually 12 months), this will save you the most money in the short term. This strategy can also slightly increase your credit score because it lowers your overall credit utilization ratio to exactly 30%. ($4,500/$15,000 = 0.3 or 30%). However, your per card ratio will suffer as the new card will be at 90% utilization, three times over the 30% ideal. Which strategy you use depends on your situation. If you are not planning any major credit purchases in the coming year, transferring the entire debt to the new card makes sense. If you are planning a large purchase, especially a home, the first option makes more sense. Improving your credit score helps you qualify for a better loan and can save you thousands in interest over 15 or 30 years.