The CARD Act of 2009 was intended to keep Americans from becoming prisoners of credit card issuers, and in many cases it has helped to do just that. However, before we start rejoicing in victory, let’s look at what’s hiding behind the curtains.
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The average credit card debt of an American household is approximately $5,000; therefore, most people are actively searching for the lowest cost ways to manage their debt until the moment they can pay it all back. If you belong to that category, you’ve probably already looked at the possibility of moving your balances onto a lower rate card—but how can you tell if it’s a good thing to do?
Shenanigans in the pre-CARD Act era
Let’s say it’s 2008 and you belong to one of the families who have a credit card debt of $5,000 and you receive an offer for a credit card from Welcoming Bank, which has “0 percent APR on balance transfers” printed in huge letters across the envelope. Being a conscientious customer, you read the terms and conditions, and you find out that the normal interest rate is about 15 percent.
With that in mind, you decide to proceed with the transfer and you are pretty happy with it, because you’re sure you can pay off $5,000 before that higher rate starts to take effect. However, since the card has a little room left, you also use it to pay some bills, amounting to $1,000, which have been gathering dust on your desk.
To kill the debt as soon as possible, you first make a whopping payment of $500, which the bank does take out of your balance, but your statement doesn’t really tell you how exactly that payment will be applied. The fact is, the bank considers the balance transfer and the bill payments to be totally different balances, which have different interest rates attached to them. Then how does the bank split the $500 amount between the two balances?
If you consider the balances two different buckets, then your bank would use the $500 to pay down the transfer bucket, while the other would be totally ignored until you’ve completely emptied that lower rate bucket. This way, you would accrue the 15 percent interest on the $1,000 each day until you have paid off the $5,000 completely. If, for example, you needed one year to get rid of the $5,000 debt, then you would pay more than $160 in interest for that bucket, and much more if it takes you more than a year.
Has the CARD Act ended these shenanigans?
Now fast forward to today, after President Obama signed the Act into law in 2009. Banks are now forced to avoid the practices described above. Banks offering credit cards now have to apply the payment to the highest rate bucket first, irrespective of the number of buckets and of the balances of each. However, there’s a glaring loophole—only payments greater than the minimum payment must be applied to in this manner. Minimum payments can still be used to pay off the lowest yielding balances first.
Consequently, if you typically only pay the minimum monthly amount on your cards, that entire payment can go to the transfer bucket, so you will be paying off your 0 percent interest rate transfer, while still getting slammed with much higher rates for any purchases.
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Other fine print to beware
Apart from the interest rates charged and the shifty payment methods for balance transfers, these cards also have upfront fees that they charge on the balance. Not long ago, these amounted to something like 1 to 3 percent, which would mean $150 on the $5,000 transfer. Now, however, these fees are generally 3 to 5 percent, which means up to another $100 charged for the transfer we considered before.
The other catch employed heavily after the CARD Act is convincing people that “professional” card offers are the best. “Professional” is just a clever marketing name for business credit cards that were not included in the provisions of the new law. So if you want to transfer balances to a professional credit card, or if you want to catch an introductory APR deal, know that the credit card company can still apply payments first to low-interest balances and ding you with maximum interest.
Credit cards are a useful tool that helps you manage your finances if they are used in a mature manner and if attention is paid to the fine print. However, they can truly help only if you learn how to moderate the charges that keep appearing, and if you can make a complete payment every month. Unnecessary fees and interest can definitely ruin your finances and you should do everything you can to avoid them.
Tim Chen is chief executive and founder of NerdWallet.com, a site dedicated to showing consumers the right and wrong way to compare credit cards.