How many credit card applications have you received this month?
I must get at least two invitations per week to sign up for another credit card. With the current economy, the financial institutions are getting pretty aggressive in their offers for new accounts. They really want your business. The banks know that it is becoming more difficult in these trying times for us to pay off our total balances each month. So more accounts are incurring interest at higher rates. To get your business, they will offer “teasers” for balance transfers: either interest-free or a low rate for a period of time. However, for their existing customers, cash advances carry interest from the day of the advance; there are no grace periods.
Why is this good business for the banks?
Well, the bank makes money in several ways. They can afford to give you a grace period on purchases because the bank charges the vendor interest on the amount of the credit card charge—usually 1% to 6% on the purchase amount. For cash advances, they only have us to pay interest on the cash advance. Then why do banks offer little or no interest on new account balance transfers? Here is where it gets tricky.
Be careful on the terms of the balance transfers. Read the detail rules for how subsequent payments are applied to your account after the balance transfer. Usually, the banks require that any payments you make are applied against the oldest portion of your credit card balance. For example, let’s say you agree to a balance transfer of $5,000 to a new credit card account, interest-free for one year.
Good deal, right?
To attract the new business, the bank only requires minimal payments against the account balance. But for subsequent purchases, the interest rate on the account is 24% per year. Assume you charge $1,000 in purchases the next month and then pay off that amount in the subsequent month to avoid the 24% interest charge. When the bank receives your payment, it applies the $1,000 to the oldest part of the balance—the balance transfer—leaving the $1,000 portion of the balance for purchases made from the previous month unpaid. Now you owe the 24% interest on the unpaid purchases balance. Ouch! As they say, the devil is in the details.
If you do not use the new credit card for any purchases after the balance transfer and use a different credit card account for purchases, you can avoid paying the interest by using the grace period to pay off the balance the following month. You can just make minimum payments on the account with the balance transfer and take advantage of the interest-free rate for a year.
Again, read the details of the balance transfer arrangement. Some banks require that the new account must be active after the transfer, making the offer far less attractive.
Keep those letters coming, folks. Send in your ideas to: The Frugal Forum, P.O. Box 693, Huntley, IL 60142 or by email to: thefrugalforum@gmail.com
