Balance transfer card is not suitable for everyday purchases unless you get one from the very few providers with positive payment allocation hierarchy.
Have you ever wondered whether getting a credit card with 0% interest on balance transfers is a good idea?
In principle, it seems like a good deal: instead of paying whatever your current provider charges, you move your entire balance to a new card and pay no interest at all.
And in principle, it is a good deal: after all, if you have a large balance and are not going to pay it off any time soon, you will be saving substantial amounts of interest.
Is there a catch? You bet there is in fact, there are several.
No financial institution operates on a charity principle, and there are very good reasons why 0% interest balance transfer deals are profitable for the providers.
A balance transfer deal features low or zero rates. These rates are usually apply for a limited time (which also varies from 9 months to over three years) and after it expires, much higher interest rates kick in.
This is the first and most obvious danger: if you don't pay your balance off by the time the deal expires, you'll end up paying interest again it might be even more than your current card. Normal APR rates for the best balance transfer cards vary from 14.9% to 19.9% (although depending on your credit record you might be offered a higher rate).
If you think that there is a strong chance that it will take you longer to clear your debt, you might be better off with a long term non-zero rate than with a shorter term 0% deal. Capital One Low Rate Balance Transfer card offers 6.9% rate until 1 Jan 2012, with a normal APR of 15.9%.
Almost all the balance transfer deals include a fee: this is now usually around 2.5-3% of the amount transferred. Some cards with lower (but not zero) balance transfer offers don't have such a fee (e.g. Capital One Fixed Rate Card which offers 9.9% rate for over three years).
Depending on the amount you have to transfer and the time you need to pay the balance off, the fee might influence your choice of the best credit cards.
== Payment Allocation Hierarchy ==
The biggest catch, and the main reason why most balance transfer cards should not be used for everyday purchases, is the negative payment allocation hierarchy.
Any repayments you make are applied to the cheapest debt first (i.e. to your 0% balance) and to the most expensive debt (e.g. cash advances or credit card cheques) last.
Effectively, you will be paying interest on your purchases for as long as it takes to clear your initial transferred balance. This can make a significant difference in interest paid on even relatively small sums.
Let's say you transfer over a balance of GBP 3,000 to a card offering a nine-month 0% balance transfer deal with the APR on purchases 15.9% and cash withdrawals 20.9%. You spend GBP 300 on purchases each month and (very unwisely) withdraw GBP 40. Your monthly repayment is GBP 400: GBP 340 should go towards your recent purchases and withdrawals, right?
Unfortunately, wrong. All of your GBP 400 a month is used to clear off your cheapest debt first. This of course means that the more expensive new purchases are accruing full interest and will not be touched until your initial GBP 3,000 balance transfer has been paid off in full. As a result, you'll be paying an extra GBP 100 a year (this adds up to an estimated GBP 500 million for all of the UK customers).
Are there any providers who don't apply negative hierarchy? Nationwide (responsible for the example above) and Saga (only available to over 50 year olds) cards have a positive payment hierarchy: the most expensive debt is paid off first. Nationwide Gold Card offers 0% rate for 13 months, with typical purchase APR of 15.9% and a positive payment hierarchy. They also throw in 0% rates on purchases for the first three months.
Any search for credit cards offering balance transfer deals will show that this last offer (0% rate on purchases) crops up quite frequently: the providers are clearly trying to encourage customers to use their balance transfer cards for everyday spending with a promise of interest-free purchases. Keep an eye on the length of the interest-free period on purchases, though: it's often much shorter than the one for balance transfers.
There are some offers on the market whose 0% deal includes balance transfers and the purchases for the same period. Only those (or a choice of a card with positive payment hierarchy) will protect you from the negative payment hierarchy danger. Several Halifax and Bank of Scotland cards (e.g. Halifax All in One Card MasterCard) offer 0% rate on both purchases and balance transfers for 9 months, Marks & Spencer Credit Card has 0% on purchases for 10 months on on balance transfers for 6 months.
== The Bottom Line ==
For most people, using the same card for balance transfer and everyday purchases is a financially risky strategy (unless it's a Nationwide card) because of the repayment hierarchy trap. It is also psychologically risky: it mixes up the repayment of older, accumulated debt and the day to day budgeting.
It's better to search for and compare credit cards separately: one for balance transfers and one for everyday purchases with a long interest-free.
Depending on how long it's going to take you to clear the entire balance (plus any purchases you make in the meantime), the choice of the best credit cards will vary. Compare credit cards, including the payment hierarchy, length of the deal, purchase rates and fees, to find the one that best suits your needs.
All rates correct at the time of writing.