How Credit Card Companies Apply Your Payments

Ever wondered how payments to your credit card are applied? It’s all spelled out in the payment allocation provision of your credit card agreement. Generally, this is within a section labeled something like “Payments” or “Making Payments.”

From my Capital One card agreement:

We may allocate payments and other credits and proceeds among the various segments of your account, and to charges and principal due within each segment, in any way we determine, including balances (including new transactions) with lower annual percentage rates (APRs) before balances with higher APRs.

What Kind of Interest Are You Accruing?

The “segments” referenced above are different ways that you can use your card–whether promotional offers or just the different rates for different types of card use. Three of the possible segments of my card are a) regular credit card transactions b) balance transfers and c) cash advances. The respective rates on each are a) 12.9% APR b) 12.9% APR and c) 22.9% APR.

So suppose that I get a cash advance of $150 and spend $150 with my credit card. I send in $150 right away (because cash advances have no grace period) and want it applied to the cash advance balance. Well, the clause above says that the credit card company has the right to allocate that money as they see fit. And they’ll use it to pay off the credit card part, first, not the cash advance. They’ll earn more interest that way.

A Sample Payment Application

Let’s run some numbers to show how that would play out.

Suppose Micah and I had $5000 of debt at 30% APR on his old credit card. Now, we called the company and they agreed to lower our APR to 13%.

But this APR would only count towards new purchases (they don’t always say this part, so be sure to check with them. it’s hidden in the fine print). Now we go out and spend $1500 on a couch. Dining room set? Flat screen tv? $1500 is almost a month’s expenses so I can’t imagine spending that much on any one thing. But we do it anyway.

We send in $250 to start paying it off. The $250 will be applied to our $1500 purchase, not our $5000 of old debt. So the $5000 will continue to accumulate interest at the old rate.

If we pay $250 every month, we’ll eventually pay off the whole thing. But we will have paid more money total (because of the higher APR) than if we’d gotten them to apply our payments to the balance with the higher APR. In this case, $369 more would go to the CC company.

I worked this out in a spreadsheet assuming 30% APY means 2.5% per month. 13% means 1.08% per month. I didn’t use the daily rate, so it’s not as precise as the actual interest would be.

Balance Transfers

This is particularly important to remember if you’re doing a balance transfer. Many cards offer excellent 0% APR rates for balance transfers and they’re a great way to pay off a loan for less. Why do the companies let you do this? They hope you’ll slip up and not pay it all off, they hope you’ll use the card once the transfer is paid off, but they really really hope you’ll use the card before paying off the balance transfer.

That way they can collect interest on you as long as it takes for you to pay off the 0% offer. So if you do transfer your balance, be sure not to use the card for anything else. If you want to use it responsibly once the transfer is all paid off, go for it. But don’t touch it until then.

Can You Change It?

So, you ask, how can I make my payment apply where I want it to?

Because it’s in your agreement, you can’t force a company to apply your payments in a way that saves you money. They’re in the business of making money and you had the option of not using your card (or not accruing multiple balances).

However, this isn’t a reason to give up. You can still call the company and ask about your options. There may be a special way of marking your payments (this is common with student and car loans). Or you may be best off transferring your card’s entire balance to a 0% APR or low-interest card and doing it right this time (not making new charges and paying it all off in time). Once you’ve transferred it to a new card, all the charges are equal.

But the best thing is not to get yourself into this circumstance to begin with. Either pay off your whole card every month or use it in such a way that you don’t have a high-interest balance just sitting around accruing interest because you can’t pay it off.

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