Understanding Credit Card Interest Rates - What the Card Companies Don't Want You to Know

Imagine for a moment that you've built up a bit of a balance on your credit card. It's a mixture of purchases, cash withdrawals and a balance transfer from a previous credit card.

You are paying off as much as you can afford every month - and yet the interest keeps piling on.

You know that each part of your balance has a different interest rate, but you are not really sure any more how your balance is made up.

Your credit card company, on the other hand, know exactly how your balance is divided up.

They are carefully making as much money as possible from your total balance, using a trick they don't like to talk about called 'negative payment hierarchy'.

Negative Payment Hierarchy - What's That?

Negative payment hierarchy is a nasty trick used by almost all UK credit card companies.

As you probably know, different types of credit card debt attract different interest rates. Cash withdrawals usually have the highest rates and balance transfers often the lowest.

To clear your balance as fast as possible, you would hope that the debt with the highest interest rate is paid off first - but that's not what happens.

Instead, the debt with the lowest interest rate is paid off first - leaving you unable to clear the most expensive parts of your balance without paying off everything in one go!

So if your cash withdrawals have the highest interest rate, they will not be paid off until you have completely cleared your purchase balance and your balance transfer - leaving you with a much larger interest bill than you would expect.

What Can I Do About It?

If you have built up a large outstanding balance on your credit card and realised that you are paying much more interest than you need to because of negative payment hierarchy, there is a solution.

Find a credit card offering 0% balance transfer and transfer your entire balance onto it.

Make sure you do not use your balance transfer card for anything else - or you will end up suffering from negative payment hierarchy again.

If you need to have a credit card to use for everyday purchases, try to find one with 0% interest on new purchases - and don't make any cash withdrawals, because guess what?

Negative payment hierarchy again