When one credit card offers a better rate than your current credit card, you may jump at the chance to apply for the card and transfer your balance. Making a balance transfer might help you save money, but it could hurt your credit score.
How Your Credit Score is Calculated
First, let's look at how credit score are calculated. Your credit score is calculated based on five basic factors: payment history, level of debt, age of credit, mix of credit, and recent credit applications. Credit card balance transfers can affect your credit score in these areas: level of debt, age of credit, and recent credit applications.
Balance Transfer and Credit Utilization
Your credit score looks at your credit card balances in relation to their respective credit limits, or your credit utilization. This part is 30% of your credit score. The higher your credit utilization, the lower your credit score will be. If you transfer a balance to a credit card with a lower credit limit than the previous card, your credit utilization will go up and you could lose credit score points. Fortunately, you can regain lost credit score points by paying down your balance quickly. Ideally, your credit card balances should be below 30% of the credit limit.
New Balance Transfer Credit Cards Lower Credit Age
Age of credit measures how long you've been using credit and counts 15% of your credit score. This part of the credit scoring calculation averages the length of your credit accounts and the age of your oldest account. If you remember grade school math, you know that adding new accounts will lower your average credit age. Transferring your credit card balance to an account that's already open won't damage your credit score in terms of credit age. However, if you open a new credit card, your average age of credit will decrease.
Applications for Balance Transfer Credit Cards Hurt
You probably know that each credit inquiry makes a small dent in your credit score. Since recent credit applications are 10% of your credit score, applying for a balance transfer credit card could cause your credit score to drop. FICO, developers of the widely-used credit score, says that inquiries typically only hurt a credit score five points or less depending on the other information in your credit report. The other good thing is that only inquiries from the past 12 months will affect your credit score.
Balance Transfers Involve More Than Credit Scores
When you're considering a balance transfer, it's important to consider more than the effect on your credit score. You should also think about the cost of the balance transfer and the cost of not doing a balance transfer.