Credit cards are used to carry out different kinds of transactions such as, purchases, balance transfers and cash advances. Hence, when it comes to paying off your due balance monthly, you have to understand credit card payment allocation. How is your payment divided among these various transactions?
Different Interest Rates
Different transactions carried out with your credit card has different interest rates and fees. For instance, the balance transfer charges differ from cash advances fees and so on. Your balances might also have different interest rates if you triggered the penalty rate by being more than 60 days delinquent on your payment. The interest rate will go back to normal on your existing balance after six timely payments, but new purchases may still be charged the penalty rate.
Payments Split Between Balances | Understanding Credit Card Payment Allocation
If you have balances with different interest rates, you would want full credit card payment allocation. Or at least mostly, toward the balance with the highest interest rate, e.g. a cash advance. That way, you can get rid of the most expensive balance first. However, credit card issuers would prefer to reduce the lowest interest rate balance first, so they receive as much interest as possible on the higher rate balance.
Initially, issuers were allowed to handle credit card payment allocation at their discretion. They would often apply these payments to the balance with the lowest interest rate, which meant higher interest rate balances would decrease slowly and incur more interest. As a result, many credit card holders were paying more interest, taking longer to pay off their balances, and not receiving the benefit of a low-interest rate promotion. But after the Credit CARD Act was passed in February 2010, this changed.
How Creditors Should Split Payments
Any credit card payment above the minimum should be applied to balances with the highest interest rate. The minimum payment, however, can be (and typically is) applied to the balance with the lowest interest rate. This will usually include balances with a promotional interest rate.
When you have balances with different interest rates, you have to pay more than the minimum to reduce your higher rate balance. If you only pay the minimum, your higher rate balance might not decrease at all. In fact, when finance charges are added, that particular balance might go up.
Since the rule became effective, more credit cards have the same interest rate for purchases and balance transfers. In this case, credit card issuers can apply the payments how they choose.
The best way to avoid payment confusion with how your credit card payment allocation is by avoiding mixing balances with different interest rates on your credit card. Don’t transfer balances to credit cards that already have a purchases balance. Likewise, avoid taking a cash advance on a credit card that already has a balance or making purchases.