Get the Most Out of Your Credit Card Payments

A new loophole means you might not be paying off your balance as soon as you thought.

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Today’s guest post comes from Odysseas Papadimitriou, chief executive of Card Hub, an online marketplace for credit card offers.

You might not be making as much progress as you think when you send in your credit card payment each month. While every payment helps, what you don’t know about payment allocation could be costing you money.

The Credit CARD Act, effective February of this year, addressed many of the issues that allowed credit card companies to take advantage of their customers. However, it left a loophole in payment allocation – the way your payments are applied to your credit card balance each month – that still leaves some wiggle room for the credit card companies.

[See How to Master the New Credit Card Rules]

Unfair payment allocation affects you if you carry balances with different APRs on the same credit card (e.g. a balance from new purchases and a balance from a balance transfer). Before the CARD Act, credit card companies used your payments to pay down your balance with the lowest APR first. Paying off the lowest APR balance first is advantageous for the credit card companies because it allows them to ‘trap’ the balance with the highest APR and continue to charge you the most interest for the longest period of time.

Unfortunately, not much has changed in this area. The CARD Act addressed the problems with payment allocation by stating that credit card companies have to apply your credit card payments above the minimum to the highest APR balance first.

While this is an improvement, the phrase “above the minimum” ensures that a portion of everyone’s credit card payment is applied in an unfair manner. In addition, 29 percent of Americans have only been able to pay the minimum in the past 12 months, according to a FINRA national survey. For this segment of consumers – the people who need the most help in paying down their debt – there is absolutely no benefit.

Unless you pay well above the minimum payment each month, you essentially have to treat the rules regarding payment allocation as though nothing has changed. Therefore, in order to pay down your most expensive debt as fast as possible, it is important to avoid mixing and matching your balances on one credit card. This is the only way to ensure that you have full control over how you pay down your debt.

Take this example: let’s say you open a credit card account and decide to transfer a balance of $10,000 onto that card because it offers a zero percent APR on balance transfers. Then let’s say you use that same card to make $1,000 worth of new purchases. The interest rate for new purchases on your credit card is 15 percent.

[See Should You Use Your Credit Card Overseas?]

If you are only paying the minimum each month, the credit card company will apply your payments to the balance with the lowest APR first – in this case the $10,000 in balance transfer debt. You will not be able to pay down the $1,000 of debt charging you 15 percent interest until you have paid off the $10,000 of balance transfer debt in its entirety. In order to control how your payments are applied, in this example, you should have one credit card for the $10,000 of balance transfer debt and a separate credit card to make new purchases.

The new rules from the CARD Act have made big strides regarding credit card companies’ openness with their customers and provided guards against unfair interest rate hikes and fees. These changes are good for you, but have undoubtedly taken a bite out of credit card companies’ profits. Taking advantage of the payment allocation loophole is a way in which credit card companies can try to make up for lost revenue, so you should be aware of it and take steps to avoid this pitfall.