How do banks make money from interest-free balance transfers?

Interest-free credit card balance transfers offer consumers a way to save money. But what's in it for the bank if they aren't charging interest?

If that's what you're wondering, here's how it works.

How interest-free balance transfers work

A credit card balance transfer gives you a way to transfer the balance on an existing high interest credit card to a new credit card with a low interest rate. The benefit to the customer is obvious: lower interest means money saved.

There are other caveats, but at a high level, this is how a balance transfers works.

• The balance transfer interest rate, usually 0%, applies to transferred debt for a period of time after the new credit card account has been opened.
• Known as the introductory period, this typically lasts for anything from 12 - 24 months or longer. Some banks have balance transfer credit cards offering an introductory rate of 0% for as long as 3 years.
• The new card issuer will ask you to provide details of the account/s you want to balance transfer debt from during the application. Usually you can balance transfer more than one account and you can choose how much to transfer (balance transfer limits permitting).
• To process the balance transfer, the new card issuer will send funds to pay off your old card and add the same amount of debt to your new card.
• The introductory balance transfer rate will be applied to the debt, now on your new card, for the duration of the introductory period.
• You can use this period of low or no interest to chip away at the outstanding balance and get out of debt.

However, introductory offers are called as such for a reason: they are only available to new customers. And therein lies how the banks make money from balance transfers.

Why the banks offer them

There are several reasons why banks need new customers.

• Competition from other banks. Banks are aware that switching is easier than ever. So they have to provide a good enough service to keep their existing customers and add more new customers than those that leave in order to report growth. As you'll see on our credit card comparisons, competition for customers remains fierce.
• Burgeoning demand for buy now pay later in key demographics. BNPL has changed the consumer finance landscape and made credit cards less appealing to Australia's increasingly debt-averse young consumers. The irony, of course, is that BNPL is still debt.
• More Australians are paying off their credit cards. This trend has been clear in the credit card industry's statistics for some time. This is great for consumers, who are spending less on interest. But from the bank's perspective, fewer people making interest payments to service their debt means less revenue. New balance transfer customers may not pay interest immediately, but the banks operate on the assumption that a percentage of them will do so once the introductory period ends.
• The usual customer churn. Things happen in consumer finance that have an effect on customer loyalty. For example, a bank may close a number of local branches, causing some of their customers to close their accounts with them and switch to a different bank. Emigration, marriage, and death also contribute to churn.
• The opportunity to cross-sell. Australian banks view the credit card as the gateway into the customer's financial life. Being a physical product, you'll see and use it when you go shopping. That product affinity makes it easier for the bank to introduce you to other products that may be more lucrative for them, particularly loans and investment products.

How they make money from balance transfers

Unsurprisingly, banks can make money from balance transfers with a combination of fees and interest.

• Balance transfer fee. Many banks charge a one-off balance transfer fee to process a balance transfer request. This fee is typically 2 – 3% of the amount being transferred. It can be added to the outstanding balance.
• Fees for late payments. If you miss a payment, the bank will charge a fee for doing so.
• Interest on new purchases and cash advances. While the balance transfer may be interest-free, any new purchases or cash advances made with your card will attract interest. Cash advances are particularly odious with interest accruing immediately at rates often higher than 20% p.a., plus they typically charge a one-off cash advance fee.
• Interest charges after the introductory period ends. If you did not pay off the balance transfer in full, whatever remains will attract interest at the purchase or cash advance rate. Whatever the rate will revert to varies between banks. Should you choose to keep the card instead of balance transferring to another one, the bank can make a significant amount of money by charging interest.