A podcast listener named Jennifer emailed me about balance transfer credit cards and her credit score. She plans to apply for a home equity line of credit soon and is concerned that getting a card before then could lower her FICO score. Here’s Jennifer’s email:
I have started listening to your 31 day money challenge podcasts in the hopes of helping me get out of debt. I have a few follow up questions pertaining to my specific situation. . . . I was interested in a 0% balance transfer but another thing to take into consideration, we live in an old home and have been planning on taking out a Home Equity loan to remodel the home. I have $40,000 in a mutual fund to put towards the home remodel and hope to get the rest from a home equity loan. As a result, I believe transferring my high interest balances to a 0% balance card will not be advantageous bc it will put a “ding” on my credit. Would you agree? I would assume I wait until after I have a home equity loan to do any balance transfers. In the meantime, I should concentrate on making sure my credit is a good as it can be. My credit is 710 my husband’s is 680.
She’s wise to consider her credit score in advance of applying for a home loan. Even a small change in a FICO score can have an over-sized affect on interest payments. According to myFICO, a drop in a FICO score of even a few points (e.g., from 665 to 655) increases interest rates by nearly .25%. Multiplied over the life of a mortgage, this seemingly small increase can result in thousands of dollars of additional interest.
Does a balance transfer card hurt your FICO score?
So does transferring high interest credit card debt to a 0% card hurt your credit score? In the short term, it absolutely can. In fact, it can lower your score for two different reasons.
In a nutshell, inquiries account for about 10% of the formula FICO uses to calculate your score. While inquiries are the least significant factor according to Tom Quinn of FICO (I interviewed him in this podcast), even a small change, as we’ve seen, can make a significant difference to your interest rate.
The second way a balance transfer can hurt your score is with credit utilization. This fact is more significant than inquiries. With credit utilization, FICO measures the amount of your revolving debt and compares it with your total available credit. The more of your credit you’ve used up (e.g., maxed out credit cards), the lower your score. A credit utilization of 20% or less is ideal.
With a balance transfer, we often max out the new card as we transfer as much high interest debt to the new card. Even though our total debt hasn’t changed (we’ve just moved it from one card to another), the new maxed out card could have a negative effect on your FICO score.
As a result, Jennifer is wise to hold off on the 0% balance transfer until she has secured her home equity line of credit.
If you have personal finance questions, don’t hesitate to email me at dr [at] doughroller [dot] net.