Three Credit Card Pitfalls That Can Be Easily Avoided

Post by Sharat on June 12, 2009 · Under Featured Articles, Hints and Tips, Personal Finance, Self Help, banking, credit cards · Comment

Many borrowers make common mistakes when using their credit cards. Here are three pitfalls that can be easily avoided.

Negative payment hierarchy

Balance Transfer cards offer attractive interest rates for borrowers who transfer existing debt from other cards on to the balance transfer card. What they usually fail to tell the borrower is the way the card calculates interest payable is usually based on negative payment hierarchy.

Negative payment hierarchy (NPH) has been explained here many times, but for first time readers, NPH is the order in which repayments on outstanding debt are allocated. Simply put the cheapest debts, or the debt which carries the least interest gets paid off first, whilst the most expensive debt continues to attract high rates of interest.

So if a borrower does opt for a balance transfer with low interest on the transferred debt, they should be careful to avoid making purchases using the same card that they transferred the debt onto, because any payment towards that card will go towards paying off the amount transferred and it is unlikely that new purchases will carry the low rates of interest.

Cash Withdrawal Charges

Without question, cash withdrawal using a credit card is one of the most expensive ways of borrowing. As soon as a borrower withdraws the money they are levied a cash advance fee ranging between 2 to 3 per cent of the amount withdrawn. The borrower is also charged a higher rate of interest on the amount withdrawn than they would, had they purchased something for the same amount using their credit card.

Unlike purchases, there is no interest free period for cash advances, so interest is charged from the moment the amount is withdrawn. Credit card cheques, which often come attached to the bottom of the card statement and are touted as an easy way to pay bills or easy access to cash is no better than withdrawing cash using a credit card and borrowing in this way will cost as much as a regular cash advance.

Minimum Payment Reductions

Borrowers often mistake it as a positive thing when card issuers reduce their minimum monthly repayments, really they are unaware of the consequences of such a move. Reducing the minimum monthly repayment usually means that the borrower is in debt to the card issuer for far longer than they would ordinarily be and ends up paying more interest than is necessary.

For example, if a borrower had a balance on their credit card of $1,000 and paid just 2% of the outstanding balance each month, it would take 400 months (that’s over 33 years!) to pay back the balance (assuming an APR of 18.9%). If the borrower were to simply add an extra $10 to their monthly repayment, they would reduce the time taken to pay the full amount owed to just 77 months (just over six years), and save themselves $2,193.23 in interest.

If a card issuer reduces the minimum monthly payment, the best way to counter would be for a borrower to set up a standing instruction with the bank to pay a fixed amount over and above the minimum, and as described, even small amounts can make large differences.

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