Ever wonder how the credit card companies can afford to offer 0% balance transfers, when such a rate is below the cost they have to pay for the money they are lending you? The trick is largely a function of the way in which your payments are generally applied. The Payment Allocation Provision which is a part of your credit card terms and conditions, i.e. the contract you made with the credit card company, usually reads something like this:
You authorize us to allocate your payments and credits in a way that is most favorable 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.
The language is pretty straight-forward, right? Sure is. Unfortunately, it is not the way you want it done.
We’ll walk through a specific example to see how this works to the credit card company’s advantage.
Let’s say you are a new customer of a credit card issuer that offered a 0% balance transfer, and you wisely moved to your new card, an outstanding balance from another lender that was charging you a higher interest rate. Let’s also presume that the card carries an APR on purchases of 13.9%.
If during the month you made a purchase, let’s say you ate dinner out and paid with your credit card. At the end of the month, when your bill arrives you plan to make a payment in excess of the cost of the dinner so interest doesn’t continue to accrue. But that’s not what will happen. The credit card company will apply your payment to the 0% balance, thereby causing the purchase APR (13.9%) to continue to be applied to your dinner expense. When the next statement arrives, you will continue to have an interest charge assessed against the dinner and any additional purchases.
This will continue every month until you have paid off all of the 0% balance transfer.
Well, in this case, the Credit CARD Law of 2009 is exactly what the doctor ordered. The new law, which will take effect in February 2010, clearly prescribes a new method which must be followed by all card companies in the application of your payments. The law states:
Upon receipt of a payment from a cardholder, the card issuer shall apply amounts in excess of the minimum payment amount first to the card balance bearing the highest rate of interest, and then to each successive balance bearing the next highest rate of interest, until the payment is exhausted.
Under this new law, the payment allocation logic will work in exactly the manner you would prefer. In our hypothetical example, the payment will first be applied to the higher interest rate balance, i.e. the dinner.
This is eminently a very fair approach, and our legislators got this one right.
If however, you are among the group of consumers who have played the ‘balance surfing’ game – accepting credit cards solely for the purpose of taking advantage of the 0% offer while never using the card for any other purpose – your days may be numbered. It is reasonable to assume that either:
a.) 0% offers will no longer be made available,
b.) balance transfer fees will rise precipitously,
c.) credit cards will carry annual fees, or
d.) some combination of fees and less attractive offers will become the norm.
But this too will be much more fair. Because after all, the price of that free money had to be paid by someone, and that cost fell on the other credit card customers in the form of higher interest rates and fees. After February 2010, it will be increasingly difficult to find a credit card with the balance-surfing promotions we’ve become accustomed to.
Please continue to check back with us at CreditGumbo.com as we delve further into various aspects of this complex and far reaching new legislation. You can find all of our related commentary on our Credit CARD Law blog page.
Labels: Credit Card, Credit Card Law
