What is the allocation of payments clause?
Allocation of payments, sometimes known as order of payments, is a clause listed in the terms and conditions of every credit card.
When you pay off a portion of your credit card balance this rule dictates the amount of interest you'll pay so, unless you pay off in full every month, it's worth knowing about.
Payment allocation: what you need to know
There are two things you need to know about your credit card balance when it comes to payment allocation.
1. It's just a balance break down
Cardholders look at their credit card statement and see one outstanding balance to pay. Say: £1257.78.
But really that balance breaks down into several different balances, all accruing interest and charges at different rates.
So, for example, that £1257.78 could break down as:
- £9 in interest charges - accruing 22.9% p.a. interest
- £40 for cash withdrawals - accruing 22.9% p.a. interest
- £208.78 in purchases - accruing 16.9% p.a. interest
- £1,000 as a balance transfer on a promotional rate of 0%
The first thing any credit cardholder needs to know about their balance, then, is what type of transactions they're making and the cost.
This goes beyond the interest rate, though that's important.
Purchases, for example, are typically subject to a standard interest free period of a number of days which means that the balance can be paid off for free.
This standard period of around 50 days applies when the credit card statement balance is paid off in full by the due date.
When only a partial payment is made, the interest free period does not apply and interest on the relevant debts will be backdated to the transaction date, and continue to accrue (more information here).
In short, the 'high to low' repayments clause is not, unfortunately, a way to chip away at a few balances and avoid interest altogether.
On the other hand, cash advance transactions rarely have a standard interest free period so they'll always accrue interest until repaid in full.
We have a full guide on which transactions count as cash advances here.
2. What comes first
When you know that you've actually got several different balances on your credit card the next question is: which one gets your money first?
In the vast majority of cases, when a cardholder pays a portion of their outstanding balance the credit card provider clears the balances accruing interest at the highest interest rates first.
This is known as a positive order of payments and it's as good as it sounds.
Think of your balance as an inverted triangle like the one below.
Positive order of payments means that you're getting your balance through the most painful part of paying, the part where the highest interest rates are burning up your money, as efficiently as possible.
Subsequent payments, the bulk of the balance, are burnt through much more slowly and the result is less to pay in interest overall.
If the cardholder with the £1257.78 debt above paid back £49 with positive order of payments they'd clear two balances which would otherwise continue to accrue interest at the card's highest rate: 22.9% p.a.
Practically, the high to low order of repayments rule pays off credit card balances in the following order:
- Interest and fees
- Insurance premiums (PPI or ID theft insurance, for example)
- Cash advance transactions (including ATM withdrawals and foreign currency purchases)
- Standard rate balance transfers
- Standard rate purchases
- Low promotional rates (life of balance transfer offers, for example)
- 0% promotional rates
When to worry
As we noted above, allocation of payments clauses are now broadly 'positive' so there's rarely a reason to worry excessively about this.
However, once upon a time, up until early 2011, credit card providers were free to allocate payments in any way they wished.
Unsurprisingly, many chose to apply monthly repayments in a way that maximised their profits: paying off the cheapest balances first and letting the most expensive ones sit accruing interest for months on end, until the card balance was paid off in full.
Think of that triangle again.
If you start with the lowest or 'coolest' balance it means storing up the interest rates that will burn through your cash and, not only that, but allowing them to grow before they're paid off in full.
No wonder that the high to low repayment rule was made mandatory after a consultation between Government and the credit card trade body the UK Cards Association forced providers' hands.
However, there are still a few instances in which payment order should be a concern.
Using two 0% offers at once
The primary problem is a complication that can arise when cardholders are using two or more 0% introductory offers at once.
Let's invent another imaginary credit card to explain the problem, a pretty good one with a 12 month 0% balance transfer offer and a 6 month 0% purchase offer.
After a month the card balance looks like this:
- £1,000 from another credit card - 0% APR
- £1,000 purchases balance - 0% APR
Now, that's two balances both at a 0% interest rate.
Should the credit card provider take that £200 from the purchases balance, because it's shortest, or the balance transfer balance, because it will eventually accrue interest at the highest rate?
There are two schools of thought.
MBNA say that the balance that will eventually accrue the highest interest rate should be paid off first.
Everyone else says payments should go to the shortest offer first.
The problem with MBNA
The shortest offer approach seems to make the most sense.
If the cardholder above made a £200 monthly repayment for six months they might well expect that, at the six month mark, the 0% purchases balance would be paid off entirely.
In fact, with MBNA, more or less the whole purchases balance would start accruing interest because where there are two balances at 0%, MBNA allocate payments first to the balance with the highest eventual rate first - which is almost always the balance transfer.
There are a few ways around this.
Cardholders could resolve to just pay off the purchases balance in full when it starts to accrue interest, paying as little as possible to the provider.
Although perhaps the simplest option for people who need to use both 0% deals are those offering an equal length 0% on balance transfers and purchases.
Finally, they could simply avoid spending on the card until the 0% purchases period is over - although note though that some interest will still be unavoidable even then as the entire balance needs to be repaid in full for any standard interest free period to apply to purchases.
As you may have guessed from this explanation, we think that the way most other providers allocate payments to two 0% deals, the shortest first, makes much more sense.
Those that want to use two 0% deals have a fifth alternative to add to those above, then: choose a deal that repays the shortest 0% offer first.
Note that, as well as branded MBNA credit cards, deals run by MBNA from providers such as Virgin Money and the AA are subject to this allocation of payments quirk.
Always check small print before relying on a certain order of payments though - not all other providers will repay the shortest 0% period first for example.