Balance transfers are a very popular reason for getting credit cards. However some care needs to be taken in order to make sure that there is no spending done on a credit card.
There are two main types of balance transfer cards. There are the very low interest rate balance transfer cards that charge an uneconomic rate of interest, but only for a relatively short period of time – usually for only a couple of months. There are also long term low interest rates for balance transfers. These tend to be quite a bit higher than the introductory credit cards. However both types of balance transfer credit cards should avoid spending on the cards.
Spending is charged at a higher rate than balance transfers on these cards. Many people assume that the spending is either charged at the same low interest rate or that it is relieved by repayments. Neither of these is the case.
It is important to understand the role of the payment hierarchy. This is where the repayments are aimed at. For example if there is a $2,500 balance transferred on to a credit card, and $200 is immediately spent on it, and there is a 0% interest rate on the balance transfer, then people would assume that if there was $100 paid back every month then there would be two months worth of interest. However there would be more than two years worth of interest. This could mean at 20% interest that there would be more than 40% paid on this $200, even though repayments are being made every month.
This payment hierarchy means that it is important to ensure that there is not any spending done on the balance transfer card. Spending on a balance transfer credit card increases the average interest rate far beyond the amount that is borrowed would suggest.
There are some good types of credit cards that could be used for spending. These include credit cards that offer rewards either in the form of cash back or in the form of goods. These rewards are for spending, which means that they are not suitable for balance transfers.
If there is not a lot of spending on the card it is still not a good idea to spend on the card. The money that is spent will take a long time before it is repaid. In these cases a no annual fee credit card is usually a good idea.
