Balance transfers have saved many a consumer from paying high-interest rates on their credit card balances. In fact, many consumers jump from credit card to credit card taking advantage of the 0% balance transfer promotions that many cards offer.
With a balance transfer, the consumer is essentially transferring a full or partial balance from Credit Card A to Credit Card B, hopefully at a lower rate. The way this works is that Credit Card B pays off your debt to Credit Card A (yes, Credit Card B actually writes Credit Card A a check). Usually, Credit Card B charges you a 3% to 5% fee on the transferred balance amount.
Credit card companies normally offer consumers a low or no rate introduction and then increase the rate markedly after a certain time period, as research has shown that consumers do not usually pay off the existing balance within the promotional, low-rate time frame.
In some cases, unfortunately, there are credit card balance transfer limits. As a result, a consumer may be prevented from transferring their entire balance on Credit Card A to Credit Card B and instead may only be able to conduct a partial balance transfer.
Types of Credit Card Transactions
There are generally three types of credit card transactions: cash advances, balance transfers, and purchases. Each of these will have a different rate according to a credit card contract, with cash advances usually being the highest.
A single credit card can have multiple balances and interest rates — one rate for purchases, another for balance transfers, and another for cash advances. Prior to the Credit Card Act of 2009, the credit card company allocated payments as they saw fit.
Not surprisingly, this meant that payments were allocated in the most profitable fashion, meaning payments were first allocated to the balance with the lowest interest rate. Therefore, higher balances accrued over a longer period of time accumulate interest charges and as a result, it took consumers longer to pay off their debt.
Thanks to the new Credit Card Reform Act, credit card companies must now apply your entire payment, minus the required minimum payment amount, to the highest interest rate balance on your card. This particular requirement took effect on February 22, 2010. This means that, provided you pay more than the minimum payment, you’ll be able to pay off your higher interest rate balances faster, lowering your interest payments thereby paying off your entire bill faster.
What This Means for Balance Transfers
Let’s say that you have a $3,000 credit card balance. $1,000 of that is from a higher-interest transaction, and the remainder has a lower interest rate. Before the new credit card rules, if you did a partial balance transfer from this credit card (A) to another (B), the check that Credit Card B gave to Credit Card A would first cover the lowest-interest items.
So you’d still be stuck with a higher interest rate on much of your remaining balance, depending on how large a balance transfer you did.
Under the new rules, though, that check from Credit Card B will go to pay off your highest interest-rate balances first. So if you do a $1,000 balance transfer, the entire balance with the higher interest rate should be paid off, saving you lots of money on Credit Card A’s payments and interest.
Consumers must still be careful, however, and read the fine print when they are transferring balances or partial balances to another credit card. If a credit card customer has been approved for a partial balance transfer only, the card company where the balance is being transferred may or may not apply the promotional 0% or low introductory rate to new purchases.
For instance, if the rates are only for balance transfers then any additional purchase you make is likely to accrue interest at the card’s interest rate, which could be as high as 20%.
Make sure to understand what the promotional rate applies to. Although payments are now being allocated more in the consumers’ favor, don’t be fooled into thinking you will be paying 0% interest for 18 months on the balance transfer AND new purchases because that likely is not the case.
Although the Credit Card Reform Act has forced credit card companies to be more transparent in terms of rates, billing, and payment allocations, it still takes a somewhat astute consumer to decipher the small print!
Rob Berger
Rob Berger is the founder of Dough Roller and the Dough Roller Money Podcast. A former securities law attorney and Forbes deputy editor, Rob is the author of the book Retire Before Mom and Dad. He educates independent investors on his YouTube channel and at RobBerger.com.
