This post comes to you from the NerdWallet.com team of personal finance bloggers, and experts in helping consumers compare rewards credit cards.
Hidden Tricks Used in Balance Transfers
If I remember well, the purpose of the CARD Act was to prevent the average American from losing his freedom to credit card companies. It did help, mostly. However, before we get carried away celebrating, let’s take a look at some of the strings attached.
The average American family has an unpaid credit card obligation of almost $5,000, so almost everybody is looking for the cheapest debt management solutions until they are able to eradicate that debt. If you’re in the same situation, you’ve probably already considered a balance transfer to a card with a low interest rate – but how can you be sure it’s the right thing to do?
The Pre-CARD Act Era
Let’s imagine that you are in one of the households that have credit cards with $5,000 in total debt and you received a credit card deal a while ago from First Caring Bank, which offers a “0% interest balance transfer”, as advertised in giant letters on the envelope. Being a sensible customer, you read the small print and learned that the usual interest rate amounts to 15%.
Continuing this example, let’s say you decided to continue the process, transferred the balance and were also satisfied because you were confident you’d be able to get rid of the $5,000 debt long before that 15% would come to haunt you. Then, as the card permitted, you also paid some bills, totaling $1,000, which had been gathered on your coffee table.
In order to pay off the debt as quickly as possible, you made a big first payment of $500, which the bank applied to your balance; however, the balance transfer and the bills are totally different balances, with different interest rates, which is not clearly reflected by your statement. The next natural question would be how is the $500 split between those balances?
You may think of the balances as different buckets; in this case, the bank would apply the entire $500 amount to the bucket marked “balance transfer.” Before the CARD Act, no payment would be directed to the second bucket until the balance transfer bucket gets emptied. In other words, you would get hit with 15% on the $1,000 until the $5,000 is paid off. If you took a year to pay off the $5,000 debt, you would accrue interest of more than $160 on the $1,000 bucket, and that would increase even further if you needed more than one year.
The Post-CARD Act Era: Any Better?
Thanks to the new credit card law approved by President Obama in 2009, banks were compelled to make serious changes in the process described above. Your bank would now have to apply the payments to the bucket that has the bigger interest rate first, no matter how many buckets there are and what balances they have. Still, you’re not 100% in the clear – there is always a catch in the small print. In fact, only payments that are higher than the minimum payment are under the obligation to be applied to the bucket with the highest interest. Banks can still apply the minimum payments to any bucket they wish.
So, if you can only afford to pay the minimum amount on your credit cards, that amount would still go to the balance transfer, so that you’ll keep paying off your low interest or 0% rate balances while being charged huge interest rates on any purchases.
To add to the interest rates charged and payment methods employed when transferring balances, banks charge upfront fees on transferred balances as well. One year ago, these fees amounted to only 1-3% – which meant up to $150 on a $5,000 transfer, nowadays they have risen closer to 3-5%, which means up to an additional $100 cost for the same transfer.
The other trick employed on a large scale after the CARD Act was passed has been attracting people towards “professional” card deals. In this case, “professional” ambiguously describes business credit cards, not covered by the new law, being offered to individuals. So, if you apply for a professional credit card, and use it to transfer a balance or simply to get an introductory APR deal, the credit card dealer would still be free to apply the payments you make to the lower-rate balances in order to charge you the highest interest possible.
Credit can be a good tool for financial management if you use cards in a responsible manner and with maximum attention to the small print. However, they can be of help only if you can mitigate any extraneous charges, and if you are able to make a full payment every month. Otherwise, interest charges and all sorts of useless fees can lead you down a path of no return.