The hidden traps of low interest credit cards

It wasn’t very long ago that a prospective credit card user simply had to arrange credit cards in the order of the APR to find the lowest rate available. Over time, however, (and due somewhat to financial product innovation) the process has become trickier and riskier for consumers.

Nowadays the interest rate which companies advertise will often be devised simply to attract customers. Lenders, for example, will advertise a card at a 4.99% introductory rate on a product that has a usual standard rate of 22.49%. Because the 4.99% rate may be more appealing than a competitors introductory rate of, for example, 9.99% (with a standard rate of 17.99%), unsuspecting borrowers will not acquire the card which offers them the better overall deal.

Furthermore, the interest rate advertised may actually be the purchase interest rate, whereas different interest rates are charged on balance transfers and cash advances. When balance transfer rates are lower than the standard interest rate, the balance transfer rate will be advertised by the lender. Credit card users who are led to believe that they will forever enjoy a low interest rate on their balance may soon find  that the standard rate is greater than their previous credit card.

Cash advances are also subject to a totally different interest rate, on 90 per cent of the credit cards on the market. The remainder charge the same rate on cash advances as they do on purchases. Cash advance rates can be excessive. It is common for lenders to charge up to an additional 5% (in excess of the purchase rate) on cash withdrawals from a credit card.  Moreover, cash advances are frequently not assigned to an interest free period, whereas many purchases are awarded 44 – 55 days of interest free periods to make full repayment. As interest begins accruing on day 1, the interest expense on a “low rate” credit card can mount very quickly.

Because credit cards charge different interest rates on various transactions they do not guarantee that a borrower will pay less in interest expenses. Lenders allocate interest repayments to the lower interest accruing transaction first so when customers make a cash advance the advanced funds will be left on the balance accruing around 24.99% interest until such times that all purchases are repaid in full. If credit card users constantly use their card for purchases, this transaction can be left on the card indefinitely leaving the borrower to pay large amounts in interest.

Credit card users should keep their eyes on the bottom line and pay more attention to the interest that will be paid over a long period of time and not just in the short term.