Be Careful With Your Credit Card

If you're looking for a 0% credit card, make sure you don't get caught out by a nasty trick called 'negative payment hierarchy.'

One thing you hear a lot about, as a personal finance writer, is other people's finances. Whether it's questions regarding the best places to stash savings, the best way to spend money abroad or the cheapest way to borrow, friends and family will happily ask, no matter how inappropriate the timing!

And one topic that is very popular is making money from credit cards. Yes, if you're new to The Fool you may find this a strange concept, but financially organised people can actually make money from one of the most expensive forms of credit around!

0% Balance transfer credit cards

The most popular way to make the most from a credit card is to take advantage of 0% credit cards for balance transfers. By transferring the debt from an expensive credit card to a 0% card, you can give yourself up to a year to pay off that balance without accruing any more interest. What's more, if you stash the money you would have used to pay off the card each month into a high paying savings account, you'll earn some interest too.

Of course, you must remember to make the minimum payment each month (setting up a direct debit is the easiest way). Also, most credit cards do charge a balance transfer fee (anything up to 3% of the balance).

0% Credit Cards For New Purchases

Alternatively, if you have no debt but fancy simply making some money, choose a 0% credit card for new purchases and get up to a year before having to repay what you spend. Save the money you spend on the credit card again into a high paying savings account and, come the end of the year when you need to pay off the balance you should have some lovely interest to spend.

Fantastic, right? Well yes...but you do need to watch out for catches. In particular, beware the credit cards that offer both 0% deals for balance transfers and new purchases. While credit cards offering exactly the same time period for both are worth going for (you can transfer your balance and put any new spending on the card) if there is a difference between the two it can cost you dearly.

For example, if a credit card offers 0% for 12 months for balance transfers and 0% for 3 months for new purchases, you could easily end up paying interest on your debt. And the reason for this is what's termed negative payment hierarchy.

Negative Payment Hierarchy

Essentially credit cards use the money you give them to pay off your debt in a particular order. And while the most sensible method would be to attack the most expensive (and thus fastest growing) types of debt first, such as cash withdrawals, most credit cards instead choose to pay off your cheapest debt first -- such as a 0% balance transfer.

So let's say you transfer a balance of £1000 to a new 0% card and then spend £50 at a restaurant on the weekend. A month later you pay in £50 to your credit card company. You might think that the £50 went towards the restaurant bill, but for many cards it wouldn't. Instead the cash will have been used against your balance transfer (£1000), meaning your new debt (£50) is happily accruing interest. Indeed, the only way to clear that new debt would be to pay off the entire balance on the credit card!

So what can you do? Well, only one credit card chooses to apply positive payment hierarchy (Nationwide BS) so unless you've chosen this credit card, if you transfer your balance to a 0% card, cut up the card and don't use it again. That way you can't be caught out. That is unless you can find a credit card that offers 0% for the same period for balance transfers and new purchases -- and they're few and far between.

One such credit card is from Capital One. It currently promises 0% for balance transfers and new purchases until 1 May 2008. What's more, its balance transfer fee is just 1.7%. Transfer your balance to this credit card and you'll be able to put new spending on the card too, and pay it off next year.

So there you have it, a few ways to take advantage of credit cards. However, heed the warning - these techniques are for disciplined Fools only; anyone concerned that they may be tempted to spend the money meant for the card should look away now and steer clear of credit cards altogether!

> Do Credit-Card Fees Stack Up?
> The Very Best Balance Transfer Cards