Beware of this credit card trap!
Credit card companies use this sneaky trick to charge you more interest. Here's how to beat it.
0% credit card deals are a fantastic way to get to grips with your debts quickly. But did you know there's a right way - and therefore a wrong way - to use them? It's all to do with nasty 'negative payment hierarchy'.
I know it's horrible jargon, but it's a good idea to understand what it means so it can't trip you up. In a nutshell, payment hierarchy refers to the order in which different types of debt - such as balance transfers, new purchases or cash advances - are repaid.
Payment hierarchy can either be negative or positive. The vast majority of credit card companies operate negative payment hierarchy. This means you are forced to pay off your cheap, interest-free debt first, leaving more expensive, interest-bearing debt festering on your card. Why? Because it's the perfect way to charge you lots more interest. Sneaky, eh?!
In fact, the US Government thinks negative payment hierarchy is so sneaky that it is considering outlawing this practice in the US next year, and making positive payment hierarchy compulsory instead. I think we should do the same thing on our side of the pond. Here's why:
How does negative payment hierarchy work?
You apply for the Barclaycard Platinum credit card which offers you an interest-free period for a year on balance transfers, and three months' 0% interest on new purchases. After that, it charges 12.4% APR.
So you transfer a balance of £3,000 onto the card and start using the card to make new purchases - but only for the first three months, because you don't want to get charged any interest.
Now you probably think that, as long as you repay everything you spent on the card during those first three months, the whole shebang will be completely interest-free.
Wrong! Unfortunately, negative payment hierarchy means your monthly repayments will actually be used to pay off the £3,000 you transferred onto the card - that is, the 0% interest debt, which isn't costing you anything. This means all the new debt you have run up by spending on the card is completely untouched, and after those first three months are up, this debt will start attracting interest at a rate of 12.4% APR.
Worse still, you cannot clear this new debt until you've paid off the entire £3,000 you originally transferred! Now, that's not what I call fair play.
How much will negative payment hierarchy cost you?
Nationwide is one of the very few credit card companies which operate positive payment hierarchy where the most expensive debts are repaid ahead of the cheapest. They reckon the average Nationwide Gold Card holder saves a whopping £213 in the first year for this reason alone.
If you're interested in the nitty gritty, here's how Nationwide arrive at this figure based on the average usage of the Gold card. The card offers 0% on balance transfers for 13 months with a 3% balance transfer fee, and new purchases are interest-free for three months. The typical APR is 15.9%. Here are the assumptions:
- A balance transfer of £2,020 is made in month one.
- £307 worth of new purchases are made every month.
- £84 is withdrawn using the card in months one and seven.
- Repayments of £359 are made every month.
After a year, the card holder would have saved £213 compared with a card that uses negative payment hierarchy over the same period.
Four ways to beat negative payment hierarchy
So, you can see why you should say no to negative payment hierarchy. Here are four ways you can beat it:
1. Use one card for your balance transfer and a different card for your spending. If there's only one type of debt held on a card then the ordering of payments becomes irrelevant. Don't forget, once the interest-free periods have finished, make sure you either repay your debt in full from then on. Or, transfer any remaining balances to new 0% cards.
2. Use a card which offers the same 0% deal on balance transfers and purchases. As with the Barclaycard example above, you'll often find the 0% deal on balance transfers is much longer - say, 12 months - than the one for new purchases - typically, three months.
It's very easy to fall foul of negative payment hierarchy due to this trick. But if you choose a card which has the same 0% deal on both, you'll know exactly when interest will start being charged. The Halifax All-in-One Mastercard is a good example of this, as it offers interest-free periods of nine months on balance transfers and spending.
3. Choose a card which operates positive payment hierarchy. These are few and far between, but the select few include: The Nationwide Gold and Classic credit cards and the Saga Platinum Card. The market-leading Virgin Credit Card handles things differently by using positive payment hierarchy temporarily before switching over to negative. Although, this isn't as fair as Nationwide and Saga, it's still better than most. You can get the full lowdown here.
4. Finally, don't borrow on a credit card at all. If you can afford to, pay your balance off in full each and every month. Then there's absolutely no way you can be caught out by negative payment hierarchy!
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