The Balance Transfer Pitfall

Credit card users often don't understand how their repayments are allocated and pay more interest as a result.

A few weeks ago, the Nationwide Building Society launched a campaign to increase awareness among credit card users about how credit card issuers allocate repayments. They say that ignorance about the system means customers are paying card providers an estimated £500 million extra in profit each year.

This applies in particular to cardholders who take advantage of 0% or lifetime balance transfer deals or who make use of cash advances. To use the Nationwide example, most credit card companies operate as follows:

• a customer makes a balance transfer to a new credit card at an 0% interest rate for 9 months;
  
  
• he then makes new purchases on the card on which interest of 15.9% is payable;
  
  
• he also takes out a bit of cash - usually even more expensive at 20.9%;

Although all providers calculate interest in different ways, most credit card issuers will put the most expensive debt at the back of the queue when allocating your monthly repayments thus ensuring they're the last debts to be paid. So, in this example, for nine months all your repayments will be allocated to the interest-free debt while your new purchases and the cash you've borrowed sit in the background racking up interest.

The last debt to be paid will be the cash advance which, if you've got a credit card with a long interest-free period could result in some whopping charges by the time you get around to paying it off. And these days, you're also likely to have been charged a typical 2% balance transfer fee, which adds even more to the cost.

HSBC has just announced that it will start allocating payments in this way from the end of the month which means that the Nationwide is now the only major credit card provider that applies payments in the customer's favour across all its credit cards.

The way around it is to use a credit card that offers equal length deals for 0% for balance transfers and new purchases and never to use a credit card for cash advances.

Don't forget that whatever sort of card you're looking for, you'll always get a great deal when you compare credit cards at the Fool.