Simply put, payment allocation is how credit-card companies pay down your debt. For example, let’s say you have a credit card with the following balances and APRs:
$100 of balance-transfer debt at 0% APR
$100 of purchase debt at 10% APR
$100 of cash-advance debt at 15% APR
____________________________
$300 total of credit-card debt
Now, if you send your credit-card company a payment for $100, that payment is not distributed equally across all of those different APR balances. Nearly all credit-card companies will pay off the debt with the lowest APR first. This means that they can continue to assess the highest APRs for the longest periods of time. Your $100 payment, in this example, will pay off your zero-percent APR, but you’ll still have the 10% APR and 15% APR debt loads on your account.
Read the terms and conditions of your credit card to see how your payments are applied. For example, as of May 2, 2008, the payment-allocation on a Chase® credit card is as follows:� “You authorize us to allocate your payments and credits in a way that is most favorable to or convenient for us. For example, you authorize us to apply your payments and credits to balances with lower APRs (such as promotional APRs) before balances with higher APRs.”
Our Recommendation:
You can avoid this pitfall by not mixing-and-matching the transactions you make on a single card. Unless your new credit card has the same introductory APR and introductory APR period for balance transfers, purchases, and cash advances, only use your new card for the transactions with the lowest APR. Otherwise, you will “trap” all of the purchases or cash advances (for example) at the highest APRs for the longest period of time. If you need to both transfer a balance and make new purchases, consider applying for two credit cards: one with a low balance-transfer APR, and one with a low APR for purchases.
Remember: Almost all credit-card companies use this payment-allocation method! Be careful and make sure you read our recommendation on picking the right credit card for your needs.
