by Diana Coman

Created on: March 08, 2009   Last Updated: July 22, 2009

Using a balance transfer card for everyday spending is a quite sure way to increase your debt rather than to get rid of it. Your balance transfer card might tempt you with low interest rates for new purchases, or it might come handy in a shop, but watch out for its special hidden caveat called repayment hierarchy. The repayment hierarchy can cause you to actually pay more than double for any item that you buy with the balance transfer card. It can cause you to actually sink in debt lower than ever. It can cause you to lose basically all of the benefits that you gained when you transfered your balance to the new card. And it should be the main reason for never using your balance transfer card for everyday spending. So, what is this dreaded repayment hierarchy and how does it affect you?

Also known as payment allocation hierarchy, the repayment hierarchy basically governs which debt gets paid off first from your credit card. In practice this usually means that when you have several debts, the one with the highest interest rate gets paid off the last. In other words, you pay the highest interest rate for the longest time and the smallest interest rate for the shortest period of time. Unfair, but this is how it works: banks are setting the rules, and they are not charity institutions.

If you thought that you can pay off any of the debts that you have on a card, think again. All you can do is to pay to the bank some money to account for the overall standing debt on one of your cards. However, the bank is the one to choose towards which of the debts of one card your money will count. Does that sound benign? Well, suppose for an instant that you have on your credit card a small debt (say 50$) with high interest rate and a large debt (say 10 000$) with low interest rate. When you make a payment of 50$, guess towards which debt do your 50$ count: towards the large one because it has a lower interest rate! Consequently, after you made your 50$ payment, you will have a debt of 9 950$ with low interest and a debt of 50$ with high interest. The bank obviously prefers that you continue having the debt with high interest rate, as this will bring them more money. The only way to control to which debt your money go is to have a single debt (or at least a single interest rate) on each card that you have. In the case of balance transfer cards, this usually means that you should not add any new debt to that card.

Not all debts are created equal in terms of the interest rate.

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