If you have a balance on your credit card, then it may include purchases you’ve made, balance transfers, any cash advances and interest added to the balance.
These may have different interest rates – your balance transfer may be at 0%, and your purchases will probably have a lower interest rate than any cash advances. So when you make a payment on your credit card which of these are paid off first?
Your credit card provider will have a set “order of payment” which sets out which of your card balances your payments will be allocated to first. Ultimately, it can have a direct influence on how much you pay in interest on your credit card. It’s sometimes referred to as an allocation of payment and, depending on the type of order of payment you have, you could find yourself forking out more in interest than you have to.
It used to be the case that card providers put your payments towards the cheapest part of your borrowing first, before you moved on to the more expensive balance, meaning you’d pay more in interest overall – but this shouldn’t happen anymore.
Different priorities for different APRs
So the “order” of payment refers to which balance on your credit card your repayments will go towards paying off first – the more expensive or the cheaper alternative. You might think that you only have one credit card balance – the total amount you owe – but in fact, this can be broken down into a few different balances.
This is because when you borrow on a credit card in more than one way – for example, utilising a balance transfer deal and then spending on the credit card too – it’s common to repay these at different levels of interest for each type of borrowing.
In the past, lenders could enforce a negative order of payment, which means you had to repay the cheapest balance first (the one with the lowest APR). However, in 2011 the UK Cards Association put in place a rule to stop lenders from doing this. This is because the balance with the higher APR would accrue interest and become more expensive while you repaid the cheaper ones, so you’d end up paying more in interest in the long run.
That’s why credit card providers should give you a positive order of payment, which allows you to repay the balance with the higher APR first. This could save you in interest payments over the long-term, and it will also mean you’ll clear your total balance faster.
Keep an eye on your spending
Although lenders should only offer a positive order of payment now, it’s important to make sure you know how much you’re spending and how much you could end up paying in interest.
If you use a balance transfer credit card and spend on it, for example, it’s wise to be aware that you’re likely going to be charged a different APR for each. Before you do so, it’s a good idea to familiarise yourself with the different fees and charges that apply to your card specifically – especially if you plan on using your credit card for more than one purpose.
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Intelligent Lending Ltd (Credit Broker). Capital One is the exclusive lender.