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The allocation of payments is a listed clause in the terms and conditions of every credit card. This clause basically states the order in which payments you make to your account will be applied.
You may look at your credit card statement and see that you owe £1257.78.
However, your credit card company looks at your account and sees that you owe:
£9 in interest charges,
£208.78 in purchases accruing 16.9% p.a. interest,
£40 for cash withdrawals accruing 22.9% p.a. interest, and
£1,000 as a balance transfer on a promotional rate of 0%.
For the credit card company, if it chooses to apply your monthly payment of £25 to your balance transfer first – it clears the debt you owe that it makes no interest on, but leaves the debts accruing interest charges on your account.
This is the allocation of payments – the order the credit card company chooses to allocate your payments to repay certain balances before others.
The above example is a very good reflection of that order – cheap or 0% balances will usually always be repaid before higher rate balances.
What are the different balances?
The different balances or transactions on your account are generally made up of:
- Interest and fees
- Insurance premiums if you have PPI
- Promotional balances – at 0% or low rates – of balance transfers and / or purchases.
- Standard rate balance transfers
- Standard rate purchases
- Cash transactions (withdrawals, foreign currency, etc…)
The allocation of payments clause in your credit card’s terms and conditions will list the above balances/transaction types in the order in which they will be repaid.
It won’t be uncommon to find them in the same order as the list above, this is because the list of balances above has been ordered in terms of their interest charges – from low to high.
Why is the allocation of payments clause so important?
In order to ensure that you use your credit card to maximum effect and minimize on interest that you pay you should make sure that you are aware of how your repayments are allocated to your credit card balance.
Many credit card companies will take your monthly repayment and then apply it to your account in a way that maximizes their profits and results in you having to pay more interest.
By familiarizing yourself with the allocation of payments you can try and avoid getting caught in this trap.
For those that repay their balance in full every month the allocation of payments will not make any difference, as the whole balance on the credit card will be cleared in full every month leaving no remaining balance to accrue interest.
However, if you have a 0% balance transfer and purchase credit card and you spread your repayments on the card you should make sure that you are aware of the allocation of payments.
For instance, if you have a credit card that offers 0% on balance transfers for twelve months and 0% on purchases for three months you may find that your monthly payments are allocated primarily to your transferred balance and any fees and interest, and then to your purchase balance.
Since your interest free period on purchases is the first to expire you will find that once your 0% purchase period ends your purchase balance will be left trapped behind the transferred balance, where it will start to accrue high interest charges.
Can the allocation of payments clause be avoided on 0% offers?
There are a couple of ways to try and avoid this debt trap.
You can either look for a credit card that offers equal interest free periods on balance transfers and purchases, so that the debt with the shorter interest free period does not get trapped behind the debt with the longer 0% period when it comes to repayments.
Or you may wish to consider separate credit cards for 0% balance transfers and 0% purchases.
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