At first glance, it seems like a good idea: you open a credit card with a low interest rate and transfer all of your balances from high-interest accounts to that one card. By consolidating you both simplify and lower your payments. But with credit card companies, if it sounds easy and like it’s a customer benefit, it’s probably neither. I should know: I used to work in credit.
Balance Transfers are a Game Designed to Make You Lose
Credit card companies have benefitted from balance transfers by hooking new customers with low rates, then getting them to spend on the card. Your payments would be applied to the balance transfer amount with the low rate, while racking up new debt at a higher rate that doesn’t get paid off until the balance transfer amount is paid off.
Think about this example. If you had a $3,000 at 2% interest from a balance transfer and $500 at 17% interest from a recent purchase, any payment you sent in would be applied to the $3,000 balance; nothing would count toward the $500 until you had the entire $3,000 paid off.
In my dark days of working in credit, we called this the “multi-bucket strategy”, meaning what you owe on the card was segmented into multiple balances, or “buckets”, each with different interest rates. Certain banks (we won’t mention any names but it rhymes with kittysank) had a reputation for aggressively seeking out ways to create more buckets, confusion, and profits for them. Another credit card issuer I know well even invested in a major technology upgrade driven by the maximization of profitability from having multiple buckets. That’s right, technology designed to trick you into owing more and more.
Sounds like a bucket of… well… you get the idea.
It’s Still a Trick
Clearly, balance transfers are a nasty trick. Recent legislation was supposed to stop this from happening by requiring credit card companies to apply your payments to the highest interest rate bucket, whether that was for a balance transfer or a purchase. But – you can always count on a catch when it comes to credit cards – the fine print of the legislation says that it only applies to payments in excess of the minimum. That means if all you can afford is the minimum payment, you are S.O.L. You could still be racking up debt at the highest interest rate while your less expensive balance transfer gets paid down.
You can find out if your credit card company is taking advantage of this loophole by reading the Terms and Conditions closely. If you’re still not clear, call until you get an answer.
You’ve Got Options
1. Never spend on cards that you’re carrying a balance on.
If for some reason you must spend on credit, make sure you’re not just adding to an already overwhelming balance.
2. Switch to debit.
If you have credit card debt, you’ve probably realized that spending on a debit card keeps you in control of your money — and that’s not just my biased love of debit talking. Research shows you’ll likely spend 12-18% less if you do, plus you can earn the same rewards as credit.
3. Choose your offers.
If you decide to go ahead with a balance transfer, look for an interest rate that matches your timeline. If it’s going to take a year or more to pay off your credit card debt, pick a card with a low long-term interest rate from a reputable bank or credit union (check out Mint’s list of options), transfer to it and start paying it off as soon as you can. If you’re going to be able to pay your balance off quickly, take advantage of a low or zero rate balance transfer offer and make sure you pay it off before that teaser rate expires.
Dan O’Malley is CEO and co-founder of PerkStreet Financial. He was formerly an executive at one of the country’s ten largest banks. Unlike other bankers, he welcomes your opinions and invites you to email him directly at domalley @ perkstreet . com.