As I always say, credit cards make for complicated business. They almost seem designed to confuse consumers, though the issuers wouldn’t agree with that statement.
Thankfully, the CARD Act and other recent measures have evened the playing field somewhat over the past several years.
But there are still plenty of “traps” if you don’t navigate carefully.
One I’d like to focus on today involves balance transfers, which if executed properly, can be a financial lifesaver, and result in lots of savings.
However, if you don’t know what you’re doing, you could actually land yourself in even more debt.
Allow me to explain.
The point of a balance transfer is to move debt from a high-APR credit card to a credit card with a lower APR, ideally 0% for some introductory period.
This will result in fewer finance charges, seeing that that a lower rate means less interest will accrue.
But if you mix your balance transfer debt with your purchase debt, bad things can happen.
Is the APR for Balance Transfers and Purchases Different?
Let’s assume you agree to execute a balance transfer to a 0% APR credit card. While seemingly a sound move, you discover that the APR for purchases on the card is well above 0%, and in fact 15.99%.
The balance transfer card happens to offer cash back rewards for purchases, so you decide to use it for new purchases as well.
When it comes time to make your first payment, you make a payment that covers all those new purchases.
Then you go on your merry way, thinking you won’t be charged any interest.
Surprise! You may actually be charged interest on those new purchases if you’re not careful.
Why you ask? Well, the Credit Cardholders’ Bill of Rights eliminated negative payment hierarchy, but with a big catch.
The new rule says the minimum credit card payment will be applied to the lowest APR balance first, and anything more than the minimum payment will go toward the highest APR balances.
Purchase balance: $500 (15.99% APR)
Balance transfer balance: $5,000 (0% APR)
Minimum payment: $50
Let’s say you want to pay off all those $500 in purchases you made during the first month of cardmembership.
You make a payment for $500, well above the minimum payment required, to cover those purchases.
The credit card issuer applies the minimum payment amount (let’s call it $50 for sake of simplicity) to the 0% APR balance transfer balance, and the remaining $450 to the purchase balance.
In other words, if you actually want to pay off that entire purchase balance, you need to make a larger payment that factors in the minimum payment amount going to the 0% APR balance.
So in our example, you’d need to make a payment of $550, with the first $50 going to the balance transfer balance, and the remaining $500 going toward the purchases in full.
Long story short, you want to avoid mixing and matching credit card balances, unless you want to whip out a calculator every month to figure out exactly what to pay.
Keep one (or two) credit card for purchases, and another for balance transfers. This will also make it easier to chip away at your debt. You’ll be able to see the debt dropping each month.
And you’ll avoid unwanted surprises if you don’t get your math 100% right.
Of course, if both the purchase and balance transfer are both set at 0% for the same period of time, which is also quite common, you won’t have to worry as much. But it could still wind up being confusing.