The Balance Transfer Catch That Can Cost You Plenty
One of the best money savers for consumers in debt is the credit card balance transfer offer -- a credit card company actively recruits you to shift your debt from a high interest card to a new card offering zero interest for 12 months or perhaps a 3.9% rate for the life of the balance transfer. These offers are attractive and can be a very good deal, especially if no balance transfer fees are attached. BUT, they're only a good deal if you transfer your balance and then put the new card away.
Here's why. Most credit card issuers have clauses like this in their credit card contracts:
"How We Apply Payments: We will apply your payment to pay off lower-rate balances before paying off higher-rate balances."
Here's an example to illustrate what that means:
Say you transfer $4,000 onto a new credit card offering 0% interest on that balance for 12 months. While the card has a 0% rate on the balance transfer, it has a 14.24% interest rate for new purchases. From the time you get this card until the transferred balance is paid off, every payment you make will go toward paying down the transferred balance---none of it will go toward new card purchases. So, in this example, any new purchases would incur a finance charge at the 14.24% rate.
Here's how that can play out. A cardholder transfers a $4,000 balance at 0%. Once she receives the card, she charges $500 in new purchases. When the bill comes, she pays $500--the same amount she made in new purchases. She assumes there will be no finance charges because all that remains is the $4,000 she transferred at 0%.
But that's not how it works. The credit card company applies that $500 payment to pay down the 0% portion of the balance, while the $500 in new purchases is charged out at 14.24%.
Previously, she had a $4,000 balance at 0%. After this, she still has a $4,000 total balance, but now the split is $3,500 ($4,000 minus the $500 payment) at 0%, and $500 at 14.24%. On the next month's bill she'll find a finance charge of roughly $5.93--the interest on the $500 in new purchases.
In addition, from this point on, she'll get a finance charge on that $500 every month until the complete balance is paid off, including all the money she transferred from the other card. And, unless she pays it all off, the previous month's finance charges will accrue and interest will be charged on those as well--in this example, next month she'll be paying a finance charge on $505.93 instead of on just $500. For someone that can't afford to pay off the transferred balance, a single purchase on the new card leads to mounting finance charges each month.
A caveat: some credit cards offer zero percent or very low rates on new purchases in addition to the tempting balance transfer offers. (See 0% Introductory Offer Credit Cards for some of these.) In this case, you can transfer your balance and makes new purchases without worry -- except for the worry of how you'll pay off those balances when the no-interest period ends.