Credit CARD Act Creates Loophole in Payment Allocation

by Odysseas Papadimitriou on June 9, 2010

LegislationAs we all know, the Credit CARD Act that came into effect earlier this year was meant to protect consumers from egregious practices by the credit card companies. By and large, the new rules do a good job in accomplishing this goal. However, there was one revision in the final draft of the bill around payment allocation that does not have the consumer’s best interest at heart.

The new payment allocation rules state that any payment above the minimum must be applied to the balance with the highest APR first. While this is an improvement from the previous payment allocation rules, it still offers no benefit to people who can only afford to pay the minimum payment each month – that’s 29 percent of Americans according to a FINRA National Survey.

That means that almost one in three people are still having their payments applied to their lowest APR balance first – allowing credit card companies to delay them from paying down their most expensive debt. For people paying above the minimum, there is only marginal benefit depending on how much more than the minimum they pay each month. The way the law is currently written guarantees that a certain percentage of everyone’s credit card payments will be allocated unfairly.

What’s worse is that originally there was, in fact, a pro-consumer version of the bill that stated that the entire payment should be applied to the balance with the highest APR. On February 11, 2009, Senator Dodd introduced a bill to the Senate (S.414) that proposed a payment allocation system in which:

“…the card issuer shall apply the payment 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.”

Unfortunately, this section was amended during negotiations in the committee process with one tiny clause. The bill signed into law states, “…the card issuer shall apply amounts in excess of the minimum payment amount first to the card balance bearing the highest rate of interest…”

It’s interesting to see that through our legislative process, the addition of a few words can completely dilute one of the main objectives of a bill. In this case, a major provision of a law that is meant to protect consumers is set up in a way that ensures that the people who need the most help get the least. It allows credit card companies such as Bank of America, Chase, Capital One, and Citibank to continue consumer-unfriendly payment allocation practices with the backing of the law.

In order to have full control of how your debt is paid down, it is my recommendation that you avoid mixing and matching transactions on any single card. You should have a separate credit card for each type of balance – one card for your purchases and one for balance transfers.

This is because if you only pay close to the minimum, you won’t be able to pay off your highest APR balance until you have finished paying off all of the lower APR balances. This could be a big problem if, for example, you have $1,000 in new purchases at 15% APR that you cannot pay down until you pay off your $10,000 in balance transferred debt at 7% APR.

While taking measures to keep your transactions separate will help, the final resolution of unfair payment allocation must come from the Federal Reserve. It is time for the Federal Reserve to act in addressing this loophole before any politicians get involved. My hope is that the Federal Reserve has learned its lesson and will no longer remain passive while credit card companies engage in unfair and deceptive practices. By taking action the Federal Reserve will ensure both a level playing field for credit card companies to compete and a payment structure that will protect consumers.


Of course, this is not fair, because the 15% interest is calculated daily, from the date of the purchase, and the payment was made after the purchase. I'm sure the bank's position is that even though the interest is calculated daily, it is not posted until the end of the billing period. That is why, if you have a similar situation, do not pay over the minimum until the following month.
January 16 at 01:31 am
CWFU, that is not correct. Whenever the previous closing balance is not zero, and you do not pay off your entire balance on your due date, you will incur interest charges on your purchases. However, what Nau has described has already happened to me. The only feasible explanation is that the allocation is done based upon closing balances from the previous month. Since Nau had no 15% purchase balance at that time, the entire payment was allocated to the 4% balance.
January 16 at 01:27 am
In answer to Nau, no, because in the first month the new purchases are "interest free" and therefore subject to 0% apr.
October 26 at 09:49 am
The situation is even worse! I have Amex card, I have a balance of, say, $10K at 4% APR.
In the beginning of the billing cycle I make a purchase of $1K.Once the charge is posted, I go ahead and pay my minimum due (say, $200) + $1K= $1.2K. So they allocate $200 to $10K balance, and the rest pays off higher (15%) APR balance of the purchase, right? WRONG! all $1,200 is applied to $10K and in the end of the cycle I get hit with 15% APR on $1K balance. Does it sound as ground for a lawsuit?
September 17 at 20:18 pm

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