Combining Balance Transfers and Rewards - Think Again!

If you're looking for a new credit card, you might be tempted to apply for one of the 'megastar' card offerings that top the best buy tables in several categories.

The idea of getting a card with a low APR, long 0% balance transfer deal, a useful 0% on purchases introductory offer, and a great cash back or rewards scheme - all on the same card - might seem like a great option, giving you a great all-round piece of plastic for your pocket.

This isn't actually such a sensible or economic choice though, even if you can find a card ticking all the right boxes at once. The basic problem is that mixing up balance transfers and rewards on the same card gets the worst out of each type of offer, while avoiding the undoubted advantages of each type of deal.

Cheapest Debts Serviced First

The reason for this lies in the detail of how your repayments are treated by the credit card companies, under a system called Allocation of Payments.

In all but a handful of cases, credit card issuers will use each payment you make to clear the cheapest type of debt you hold on your account before the more expensive types. For example, if you withdraw cash with your card at a rate of 25% APR, none of your payment will go towards reducing this debt until all your purchase debt at a lower rate has been cleared.

Card issuers do this to maximize their profits - they obviously want the debt that's earning them the most money to stick around longer than the debt they're making less from.

How This Affects Balance Transfers and Rewards

Money borrowed on your card at a temporary rate of 0% - which is all that a balance transfer essentially is - is going to have to be cleared before any debt built up by spending with the card is even touched.

Given the length of today's best balance transfer deals, this can mean your purchases are sat around being charged at a full rate of interest for well over a year, even if you clear your spending balance every month - 100% of your repayment will go towards your balance transfer until it's completely cleared.

And, considering that the only way to earn rewards is to spend with your card, it's easy to see that whatever you gain in terms of rewards is probably going to be completely overwhelmed by the interest charged on your purchases while you still have some 0% debt to clear.

Carry More Than One Card

The solution to this problem is clear: don't use a balance transfer card for spending on, even if you have a great rewards program on it - the numbers simply don't add up. Although having several credit cards isn't always a great idea, in this scenario at least it makes perfect financial sense: have one card to save money with a 0% balance transfer, while use a different one to earn rewards or cash back (always clearing the balance in full each month of course).

Don't fall into the credit card companies' trap of being blinded by too many features on an all-singing, all-dancing card - use a card in a way that maximizes the advantages of it's best feature, and ignore the rest.


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