The Balance Transfer Catch That Can Cost You Plenty

Filed in archive Credit on July 12, 2006

In this Monday's Dallas Morning News, I was quoted in an article about balance transfer credit card offers.

While talking to the News' personal finance columnist, Pamela Yip, on the phone, I particularly stressed a clause that I think many consumers miss -- that you may transfer a balance at zero percent interest, but any new purchases on the card will be charged at the regular interest rate AND any payments you make will go toward that zero-percent balance first.

I've expanded on this point a bit today at IndexCreditCards.com. No need to rehash it all on this page, but here's the pertinent example I wanted people to understand:

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.

I also include the caveat that there are some credit cards that combine a zero percent introductory rate on purchases with the 0% on balance transfers, which does allow you to continue making purchases. But, unless you are able to qualify for one of those deals, it's best to put that new credit card on ice until you've paid off the complete balance.