The Old Way
When the Credit CARD Act of 2009 went into effect, most people assumed it would spell the end of the 0 percent balance transfer offer. Why? Because prior to the reform, banks could apply payments however they wanted. Instead of allocating a payment towards the higher rate balances (i.e. purchases at the standard APR), they would do the opposite and apply all payments towards the lower rate balances first. As a result, if a customer was carrying a balance at 0 percent and also using the card for purchases, they would still incur finance charges, even if the amount of payments were equal to their purchases.
The New Way
The new reform requires that all payments go towards the higher rate balances first. No longer can banks give with one hand and take with the other. So how are they still making money on these zero interest offers? Well, consider these three reasons and you will understand how it’s done.
Reason #1. Balance transfer fees
Even though the customer may be getting 0% for 12-18 months, there’s almost always a balance transfer fee involved. In the post-reform era, these fees have gone up (averaging 3-5% now) and are now levied by almost every bank out there.
Take Citigroup (C) as an example. From my experience, they are perhaps the most popular bank for 0% offers. The Citi Simplicity card offers an intro 0 percent for 18 months, but the customer will still have to pay a fee equal to 3 percent of the balance transfer amount, which is actually quite low relative to other banks. The Freedom card from Chase (JPM) charges up to a 5 percent fee.
Conclusion? Even though the balance accrues 0 percent for a certain period of time, the credit card company is still making money in the form of a transfer fee. On big balances of several thousand dollars or higher, that may equal hundreds of dollars.
Reason #2: Record-low borrowing for banks
Perhaps the biggest reason balance transfers are so profitable is because of the rates banks pay to borrow their money… which of course is next to nothing right now.
The Fed has kept benchmark interest rates near zero since December 2008. As long as that continues, the 3-5 percent balance transfer fees should be more than enough to cover the bank’s borrowing costs. Never before in the history of 0% offers (they’ve been around since the late 80’s) have we seen this phenomenon, where banks can get money so cheap.
Reason #3: Hybrid offers
It used to be that credit card companies would offer either 0 percent or a cash back bonus, but never both.
Now banks are combining the two offers, as a motive for balance transfer customers to also spend. For example, the normal Chase Freedom offer is a $200 bonus and it does not come with 0 percent. However, Chase has an alternate version with only a $100 bonus plus 0 percent for 12 months. The latter of which obviously attracts the balance carrier. It also encourages them to buy more and since the 0-percent rate on purchases is only 6 months long, it means they'll be more likely to reap finance charges from purchases, too.
The 0-percent balance transfer offers are a big win for banks, as long as they have the ability to borrow that money for almost nothing.
That being said, over the next several years as the Fed inches rates up, it’s unclear whether these 0-percent offers will still work. Why? Because the banks have never experienced normal borrowing costs in the post-reform era. I already explained why it worked prior to that, but with the new rules in effect, will it still be profitable to give 0% when they’re paying 4-5 percent to borrow that money from the Fed? Only time will tell.
Meanwhile, if you’re curious as to which card issuers are the most popular for balance transfers, on CreditCardForum, the advertised 0-percent offers from Citi, Discover (DFS), and Chase seem to perform the best. So as long as the Fed’s low-rate gravy train continues, I expect these three issuers to fare well in this arena.
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