The following is a guest post by the NerdWallet.com team. NerdWallet is a website that helps you compare and find low interest rate credit card offers. The Nerdwallet team of finance bloggers and experts write for Forbes Moneybuilder Blog, Huffington Post, the Christian Science Monitor and many other outlets.
Do you remember the CARD Act of 2009? If so, then you know it was created to protect American consumers from being held hostage by credit card companies. This Act has done a good job in some respects, but there are some dirty tricks that you should be aware of before truly claiming victory.
Surveys show that the average American household has nearly $5,000 in unpaid credit card debt, most of whom are searching for ways to pay off these debts cheaply. If you’re like most, you have probably thought of transferring over your balance from higher interest cards to a card with a low introductory interest rate, but should you?
The Use of Balance Transfers Before the CARD Act
Let’s say you have the average household credit card debt of $5,000, and last year you responded to an offer from First Friendly Bank for a 0% APR on a balance transfer credit card. Likely you decided to do this (after reading the fine print of course), thinking that you could pay off your debt before the intro period ended and the higher 15% interest rate kicked in.
So you went ahead and got the credit card and transferred your balance over. You felt confident that you would be able to pay off the $5,000, and even used the extra room on the credit card to pay off an accumulating pile of other bills that was worth $1,000.
Eager to get rid of some of your debt, you decide to send in $500 as a first payment and it is applied to your balance. Now, you likely won’t see this noted on your statement, but your balance transfer is accounted for by your bank as a separate balance from your other bills, and the two incur their own separate interest rates. Now, what will the bank do to split the $500 you sent in between the two balances?
Just think of these two balances as two different bowls. The bank would previously have put your entire $500 payment in the balance transfer bowl. During the pre-CARD Act era, the other bowl wouldn’t have seen any of that money until the other balance transfer bowl was completely taken care of. So you would be charged the full 15% interest on the $1,000 that you spent until you fully paid off the $5,000 from the other balance. If it ended up taking you a full year to pay this off, you would have generated $160 worth of interest on your $1,000 bowl. Then if it took more than a year, that $160 would continue to grow.
Are Balance Transfers Safer Post-CARD Act?
President Obama signed credit card legislation in 2009 that changed the way banks have to behave in situations like that above. Now, these credit card companies are required to apply payments made by consumers to the bowl with the higher interest rate first, no matter how many bowls you have and which have the biggest balances. Of course, this doesn’t mean that it is 100 percent safe – nothing ever truly is. There is a catch within the fine print so that only payments greater than the minimum payment have to be applied to the bowl with the highest interest. So they are still given the freedom to put minimum payments to any of the bowls they wish to.
If you’re only able to pay the minimum payments on your charge cards, all of those payments will be going to the balance transfer bowl. This means that you are going to continue paying off your low interest or 0% credit card balances while the purchases you make still get charged the higher APRs. This is why it is important for consumers to do everything within their power to pay more than just the minimum payment monthly.
Other Dirty Secrets to Know About
Other than the interest rates that are being charged by these banks and the methods they use for the balance transfers, financial institutions are charging upfront fees for transferred balances. A little over a year ago, these fees were typically around 3%, which means you’d pay about $150 upfront for your $5,000 balance transfer. Today, many of these transfer fees are even higher at 5%, which is $250 for a $5,000 balance transfer.
Then there is the problem with professional credit card schemes that banks have been employing since the CARD Act was established. These professional credit cards are none other than business credit cards, which aren’t protected by the Act. So if you decide to get one of these business cards for transferring your balance or in order to take advantage of deals on introductory purchase APRs, the bank has the freedom to put the payments you make on low-rate balances, while charging you the max interest rates from other balances.
If used responsibly, credit cards can indeed be a great way to manage money, but it’s important to keep an eye on the fine print. The only way that these credit cards will work favorably for you is if you are knowledgeable about mitigating the fees that you have to face at each turn, and if you are able to make full payments each month. Dealing with unnecessary interest fees can quickly trip you down a dark abyss, so try to avoid them as best you can, perhaps look at personal loans with fixed rates and payments as a more predictable alternative.
Image courtesy of Steven Depolo.
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