Understanding Credit Card Balance Transfers

The 0% introductory interest rate on balance transfers is a common perk of credit cards targeted to consumers with good to excellent credit. While this offer looks great on the surface, people who take advantage of it might find themselves on the hook for unexpected interest charges.

The problem is that transferring a balance means carrying a monthly balance, and carrying a monthly balance – even one with a 0% interest rate – can mean losing the credit card’s grace period and paying surprise interest charges on new purchases. Here’s what you need to know about this problem and how to avoid it.

The grace period is the time between when your credit card billing cycle ends and when your credit card bill is due, during which you don’t have to pay interest on your purchases. By law, it must be at least 21 days. You only get the grace period if you aren’t carrying a balance on your credit card. What many consumers don’t realize is that carrying a balance from doing a promotional balance transfer – not just from making purchases – can mean losing the grace period.

With no grace period, if you make any purchases on your new credit card after completing your balance transfer, you'll rack up interest charges on those purchases from the moment you make them. When that happens, some of the money you’re saving by having a 0% interest rate on the balance transfer will go right back out of your pocket.

The only way to get the grace period back on your card and stop paying interest is to pay off the entire balance transfer as well as all your new purchases. If you had enough cash saved up to do that, you probably wouldn’t have done the balance transfer in the first place.

A transfer can save you money…

Say you have a $5,000 balance on a credit card with a 20% APR. Carrying that balance is costing you $1,000 a year at this rate. Then, you get a 0% balance transfer offer on a new credit card. You can move your $5,000 balance to the new card and you’ll have a whole year to pay it off with no interest. You just have to pay a 3% fee to transfer the balance, which amounts to $150. (Balance transfer fees typically range from 3% to 5% of the amount transferred.)

Even after the fee, you’ll come out way ahead by not paying interest for a year, as long as you put about $415 per month toward your $5,000 balance so that it’s paid in full by the end of the promotional period. (For more math, see "Are Balance Transfers Worth It?")

…Unless you buy something else on that card.

Let's say you need to fork over $150 for toilet paper, paper towels and other household essentials during a routine shopping trip and you charge it to your new card, the same card to which you’ve transferred the balance.

You assume that, if you pay off the $150 when your bill comes due in three weeks, you won't owe any interest on the purchase – after all, you just made it. And you know you’ll have the money because your financial situation has improved since you racked up that $5,000 balance. You were unemployed then; you have a job now and you’re not taking on new debt, just cleaning up the past. You just charged the purchase to your card for convenience.

But when your credit card statement arrives, you find you’ve been charged 15% APR – your new card’s interest rate on purchases – on your $150 purchase. It’s a small amount, but what if you had charged your child’s college tuition for the semester? Plus, there’s the principle of the thing: If you’re going to pay interest or fees to a credit card company, you want to do it knowingly, not because the company caught you off guard.

It gets worse. In your mind, the amount you owe for the balance transfer – and the amount you owe for purchases – are separate. Just send in your payment for $150 plus the $1.25 or so in interest, and you’ve got your grace period back and everything is fine, you think. But that depends on how your credit card applies your payments.

The rules are spelled out in the fine print. If your credit card company applies payments to the lowest-interest balances first, your $151.25 will go toward your balance transfer amount, and your $150 purchase will keep sitting there accruing interest at 15% until you pay off your entire balance transfer, your purchase and all the interest you’ve accrued.

The Consumer Financial Protection Bureau (CFPB) says many card issuers don't make these terms clear in their promotional offers, and that it plans to start cracking down on card issuers. It calls card issuers' failure to clearly disclose the loss of the grace period "deceptive" and potentially "abusive."

Credit card issuers are required to tell consumers how the grace period works in marketing materials, in application materials, on account statements and with balance transfer or cash advance checks, the CFPB states. It says some issuers aren't doing so in a way that consumers can easily understand. In fact, the fine print might not even use the term “grace period.” It might say something like “avoiding interest on purchases.” 

Also bear in mind that many balance transfer offers don’t guarantee that you will actually receive a 0% balance transfer for the maximum number of months in the introductory period. Your credit score determines what you actually get. Unless you have excellent credit, you could wind up with a low-interest balance transfer for a fraction of the time you expected.

Here's a real-life example from Discover that indicates you will pay interest on new purchases, with no grace period, if you take advantage of a balance transfer offer:

“You can avoid interest on new purchases you make if you pay your entire balance in full each month. This means unless you have a 0% introductory purchase APR, you will pay interest on new purchases if you do not pay the balances you transfer under this offer in full by the first payment due date.” 

Citi puts it this way:

“If you transfer a balance, interest will be charged on purchases made with your credit card, unless your purchases have a 0% APR, or you pay the entire balance (including any transferred balances) in full each month by the payment due date.” 

Wells Fargo is somewhat clearer – and at least uses the term "grace period":

“If you transfer amounts owed to another creditor and maintain a balance on this credit card account, you will not qualify for future grace periods on new purchases as long as a balance remains on this account.” 

Then there's Juniper Bank's version:

“We will not charge you interest on any purchases if you pay your entire balance by the due date each month. In addition, during this introductory period we will not charge you interest on purchases if you pay by the due date each month your outstanding statement balance minus any new 0% introductory APR Balance Transfer balances.” 

Keep in mind the CFPB’s warning that consumers may not be able to find the information they need in the fine print. Sometimes these statements aren’t even in the credit card offer itself, but elsewhere on the credit card issuer’s website, such as in a help, FAQ or customer service area.

If the terms of the grace period for purchases after you do a balance transfer are unclear to you, you have three options:

1. Pass on the offer and look for one with clearer terms.

2. Take the 0% balance transfer offer, but don't use the card for any purchases until you've completely paid off the balance transfer. 

3. Choose a credit card that offers a 0% introductory APR for the same number of months on both balance transfers and new purchases. One such is the The Discover (NYSE: DFS) it Card.

If you want to accept a balance transfer offer, don’t assume that the only costs are the balance transfer fee plus the interest rate, if any, charged on the transferred balance. If you use the card to make new purchases, be aware that you may incur interest on those charges from the day you make them, rather than getting the interest-free grace period you normally receive when you pay off your purchases in full and on time.

Don't sign for any new credit card with the goal of using its balance transfer promotion until you know exactly how balance transfers work there and how they affect new purchases. For more on the topic, see "The Pros And Cons of Balance Transfers."