How Does Balance Transfer Affect Your Credit Score?

Thinking about a balance transfer? Before you decide, it’s important to know how it could affect your credit score. A change in your credit score generally influences your chances of loan and credit card approvals in the future. While a balance transfer can lower interest and simplify payments, it may also change your credit score. Actions like opening a new credit card or closing an old one could temporarily lower your score. Understanding these effects can help you make a smarter choice and keep your credit healthy.

To understand the effects, it is essential to first understand the process of a balance transfer and its implications. A balance transfer is the process of moving an outstanding debt from one credit account to another, usually to take advantage of a lower interest rate. This is commonly done with credit cards or loans to save on interest costs and consolidate payments. By transferring your balance, you can reduce the financial burden of high-interest debt and potentially pay off your dues faster. However, balance transfers may come with fees, and it’s essential to ensure you can manage payments on the new account to avoid further financial strain.

While a balance transfer can help manage debt, it may negatively impact your credit score in several ways:

Hard Inquiry on Your Credit Report

Applying for a new credit card or loan for the transfer results in a hard inquiry, which can temporarily lower your score

Credit Utilisation Ratio

If the transferred balance takes up a significant portion of the new credit limit, your utilisation ratio may increase, negatively affecting your score

Shortening Your Credit History

Closing older accounts after the transfer reduces your credit history’s average age, which can impact your score

Potential for Missed Payments

If you overlook the first payment on the new account or the remaining balance on the old one, it could lead to missed payments. This can severely harm your credit score.

Perception of Financial Risk

Lenders may view frequent balance transfers as a sign of financial instability, which could affect future loan approvals

Being aware of these factors can help you make informed decisions and manage your credit score better.

Yes, a balance transfer can improve your credit score if managed properly. There are several ways in which it can contribute to enhancing your score. Some of these are as follows:

Lower Credit Utilisation

When you transfer a balance to a new credit card with a higher limit, you automatically increase the credit available to you. If you keep the old credit card account open after the transfer and avoid using it for new purchases, this action further increases your total credit limit without adding more debt. This improves your credit utilisation ratio significantly, even if you don’t pay down the balance right away.

Imagine you have a credit card with a ₹1 Lakh limit and a balance of ₹70,000. This means your credit utilisation ratio is 70%, which can negatively affect your credit score. Now, suppose you transfer this balance to a new credit card with a limit of ₹2 Lakhs. After the transfer, your total credit limit becomes ₹3 Lakhs, while your total balance remains ₹70,000. This reduces your utilisation ratio to about 23.33% (₹70,000 / ₹3 Lakhs x 100), which is below the recommended 30%. This boosts your credit score within a short period.

Improve Repayment History

For a more long-term strategy, ensure that the terms of the credit after the transfer are favourable. This will ensure timely payments which are easier to manage, reducing the risk of defaulting and missed payments. Let’s understand this better with an example.

 

Suppose you have transferred the balance of a personal loan to another lender offering a lower interest rate. After the transfer, your EMI was reduced from ₹15,000 to ₹10,000, which is easier for you to pay and fits within your monthly budget. Making these payments on time every month will demonstrate financial discipline and reliability. This is essential as your repayment history is one of the most important factors taken into consideration when your credit score is calculated.

When you apply for a balance transfer, the lender checks your credit report, which results in a hard inquiry. This can affect your credit score in the following ways:

• Temporary Drop in Score: A hard inquiry may lead to a small drop in your credit score. This is normal and the impact usually fades after a few months.
  

• Multiple Applications Can Add Up: If you apply for several balance transfers or new credit cards in a short time, the number of hard inquiries increases. Too many inquiries might make lenders think you’re struggling financially, which could lead to a lower score.
  

• Timing Matters: To reduce the impact, try to space out your credit applications. If you’re planning a balance transfer, only apply when you’re confident about your eligibility for the new card.

 

Although the effect of a single hard inquiry is small, repeated inquiries can harm your credit over time. Being selective and strategic with balance transfers helps protect your score while managing your debt more effectively.