Know the best payoff method for a card with varying APRs on different balances
Did you know that it’s possible to have only one credit card, but still have more than one balance?
Say you open a new card and it has a low interest rate introductory period during which you make charges and don’t pay the entire balance off. That’s balance No. 1. Soon the intro period ends and you begin making purchases with the card’s regular APR, creating balance No. 2. Somewhere along the way, you decide make a balance transfer from another card to this new card so everything is one place, thus introducing balance No. 3. And finally, when you’re totally cash-strapped, you have to take a cash advance, making way for balance No. 4.
Your credit card can have any combination of these different balance types, but when more than one are added to your account, the balances are treated separately because different transaction types typically have different APRs, and sometimes those rates fluctuate.
“It’s not uncommon to have multiple rates,” says Kathryn Bossler, a financial counselor with GreenPath Debt Solutions. “There is the teaser rate when you just open a card, which might be 0 percent for a year. That promo rate might apply to purchases or transfers or both. Then there are also rates on purchases, balance transfers and any cash advances you’ve received.”
Anything in excess of the minimum payment will go toward the higher interest balances first so they will get paid down more quickly.
Navy Federal Credit Union
The good news is that your credit card statement breaks down each of your balances separately so you can see how much you owe, and how much interest is being accrued for each debt, says Bossler. The big question is: On which balances will your payments be applied?
Because you live in a post-CARD Act world (that’s the Credit Card Accountability Responsibility and Disclosure Act of 2009), your consumer rights are better protected. Here’s what you need to know about carrying multiple balances and how to pay them down in the best way possible:
The CARD Act says …
Prior to the CARD Act, there was no regulation for how card issuers had to apply your payments if there were different balances. Many would take your lump sum payment and throw it at the 0 percent or lower interest rates first. That way, you paid off the debt with the lowest rate first, without making a dent in the outstanding balance on the debt with the higher rate. The result was the one most favorable to the lender: You’d pay the higher interest rate for a longer period.
Here’s the catch: Credit issuers can do whatever they want with your minimum payment. “How the minimum payment is applied is based on your cardholder agreement, and there is no regulation there. They can apply it however they are going to apply it. It’s the amount above that where the regulation comes in,” says Bossler.
Therefore, as is the case with many other card payoff strategies, the key to making a dent in your balances is to pay more than the minimum.
Balance transfer bonanza
Dealing with balance transfers can also be confusing since it is possible to have more than one on a card. “If you were to request a balance transfer today and one a month from now, your payment is typically going to be applied to the one that was made first,” says Freeman.
But again — if you’re carrying any higher interest balances as well, they will be tackled before balance transfers, making it difficult to pay off the transfers before the zero interest period is up.
The one exception to the rule comes from the CARD Act, which states that any payment in excess of the minimum that is within a 60-day window (or two billing cycles) of a balance transfer promotional period expiring will go toward that balance first, says Bossler.
How the minimum payment is applied is based on your cardholder agreement, and there is no regulation there. They can apply it however they are going to apply it.
|— Kathryn Bossler|
Greenpath Debt Solutions
That being said, ideally you don’t ever want to get to that point. “If you’re going to do a transfer from a higher rate card, you should map out a plan for paying that off,” says Freeman. “Don’t just transfer and make minimum payments.”
To ensure you pay down balance transfer debt on time, divide the total transfer amount by the number of months in the deferred interest period, and pay at least that amount each month. Just remember that all bets are off if you have other balances on the card. Use our 0-percent balance transfer payoff calculator to see how quickly you can pay off your debt under different scenarios.
Other multiple balance strategies
In general, the more debt you carry — no matter the interest rate — the harder you’ll have to work to pay it off. Still, you can give yourself an advantage by finding a card with favorable terms from the get-go.
“When it comes to payment allocation, it all comes back to interest rates,” says Freeman. Choosing a card program that has minimal fees and low rates will help you in the long run since that’s where your payment will be applied first, he says.
However, paying just $10 above the minimum is not enough, says Bossler. “Look more at the balances you owe, and take a look at the breakdown of how much you owe on the higher interest promotions,” she says. “If you have a cash advance, for instance, see how much you can reasonably afford to pay on that so you can get it taken care of more quickly.”
Speaking of cash advances, some people don’t realize there are different interest rates for them as well, according to Bossler. “Remember, it’s different from simply pulling money from an ATM,” she says. You’ll typically face an upfront fee of about 5 percent for each transaction, followed by an interest rates in the 20s.
Those promotional checks you might get in the mail from your credit issuer are also different. “Those might not be the same as a cash advance interest rate since they are promotional,” says Bossler. However, those lower rates will eventually expire, so read carefully before you cash in.
If you are confused about your balances and how your payments are allocated, call your issuer and ask for a breakdown or explanation, says Bossler.
“They are very willing to give you good information about how it works,” she says. You can also reach out to Consumer Financial Protection Bureau, which has information on regulations in simple terms.
If at all possible, your ultimate goal should be to not carry any balances at all and to pay off 0-percent interest debt before the deadline. If you do find yourself juggling multiple balances, keep throwing as much as you can toward the higher-interest debts until you reach zero.
See related: How minimum payments are applied to small balances, Clarifying new rules for how card payments are applied to balances