Credit Card Payment Allocation Explained
How Your Payments Are Applied to Different Balances
Your credit card balance isn't really just one big credit card balance, particularly if you've made different types of transactions, e.g. any combination of purchases, balances transfers, or cash advances. These balances are actually separate and your monthly credit card payments could get divided up among the balances or applied to just one balance. So, you may think you're paying off your balance transfer, but your payments are actually being applied to your purchases balance.
When Do Balances Have Different Interest Rates?
You might have balances with different interest rates if you've made different types of transactions on your credit card, e.g. purchases, balance transfers, and cash advances or a cash advance equivalent. 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.
How You Want Your Payments Split Between Balances
If you have balances with different interest rates, you want your monthly credit card payments to be allocated fully, 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.
Prior to the Credit CARD Act taking effect in February 2010, credit card issuers could legally allocate payments 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.
The Law on How Creditors Should Split Credit Card Payments
Now, with the Credit CARD Act in effect, 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, which will usually include balances with a promotional interest rate.
When you have balances with different interest rates, this 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 is allocated 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 or make purchases on a credit card with a balance transfer. Likewise, avoid taking a cash advance on a credit card that already has a balance or making purchases/transferring balances to credit cards with a cash advance balance.