Most people assume, if they have ever really thought about it, that all credit card balances are alike. There are actually three types. These will be explained below.
There are actually three types of credit card balances, and they all affect the customer differently. The first balance is for the purchases you have made. Next you have the balance on balance transfers, and finally the balance of your cash advances.
The differences on these balances on your credit card come from the way interest is charged and the way payments are credited to your account. There is such a thing that is called “payment hierarchy”, which details which of these three types of credit card balances will be paid first, second and third. This is defined in the terms of agreement in each card application.
Many people assume that the oldest charges will be the ones that are paid first. Actually, this is not true, as payment hierarchy has nothing to do with the age of the charge or balance. It is determined by the interest rate on the particular type of balance. The way each of the three types of balances is paid is shown below.
Balance Transfers
Balance transfers are exactly what the term implies. They are transfers from another credit card which is charging high interest to your card that is giving you a low promotional rate of interest. You may have even taken out another card for the sole purpose of using it as a balance transfer card. The promotional rate on these balance transfers are very low, and sometimes even 0%. This rate of interest is offered for six, nine or twelve months. During this time, balance transfers accrue little interest, and as such, they will be the first balance that your payments will be applied to.
Purchase Balances
Purchase balances are the balances on your actual purchases with your credit card. Of the three types of balances, this is the balance that will accrue interest at the regular rate of the card. The interest is a great deal higher than the promotional rate that you pay with a balance transfer, but not as high as the interest on cash advances. Purchase balances will be paid after your balance transfers have been paid.
Cash Advances
The cash advance balance is the last of the three types of balances to be paid. The cash advances on your credit card charge you the highest rate of interest of the three types. With this being said, and now knowing the payment hierarchy, it is easy to understand why this amount is the last one paid.
Quite simply, it is to the advantage of the card issuer to apply payments to the lowest interest balance first. In that way, the higher interest balances, which are so much more profitable to the lender, will accrue interest while you are paying off the lower interest balances. It only makes good business sense for the lender to do this.
Now you know how the three different balances work. To save yourself some money, keep this in mind when you pull out your credit card.
