The rates of interest that are charged on a UK credit card are not always the same. The way that cards are used may result in a variety of different charges being made. This can impact on repayment costs if the credit card issuer manages its order of payments on a negative payment hierarchy basis. How does this work?
What is a Negative Payment Hierarchy?
Credit card companies can split purchases into different types, each of which may have a different underlying interest charge. If the card issuer uses a negative payment hierarchy then any money that is paid into the account will be allocated to the spending with the lowest interest rate. More expensive purchases will be left to accrue their higher interest charges until the cheapest debt is fully repaid.
How are Credit Card Interest Rates Different?
Many credit cards offer users a range of ways to use their card. Each of these may come with a different interest rate. So, for example, standard purchases made on a card may have one rate whilst ATM cash advances and the use of credit card cheques may have higher rates. Although this may be clearly laid out in the agreement the consumer signs, they may not fully understand what it actually means.
Why Does the Order of Payments Matter?
The order of payments dictate which debt is paid off first. Those with a negative hierarchy will see their payments go towards paying off the cheapest debts to the card issuers (i.e. those that make them least money). This means that the individual will incur higher rate interest charges on more expensive borrowings as they will not be repaid until the lower rate ones are dealt with. This, quite simply, costs them more money.
On the other hand, if a consumer is paying off a certain sum on a card with a positive order of payments then the more expensive debt will be paid off first and the cheapest last. This may mean lower earnings for the card issuer but it also means lower overall costs to the card holder.
Will the Order of Payments System Change?
The UK government is currently researching ways that credit card companies can deal with their customers better and with more transparency. One of the issues under the spotlight is the way that payment order is allocated. So, there may be legislation in place in the future that changes this.
Plus, since the consultation process started, card companies themselves have started to make moves to change industry practice. This may ensure that all money that is paid in over the minimum payment amount would be allocated to the most expensive debt on a card. This would, however, still leave credit card companies able to use the minimum payment in a negative order if they wish.
How to Avoid the Extra Costs of Negative Order of Payments
Consumers can avoid this happening by using their credit cards wisely. For example, they could:
- Not use a card to withdraw cash from ATMs in the first place.
- Not use credit card cheques to borrow money from a card account.
- Find a credit card that operates a positive order of payments.
Often, however, people use their cards in these ways because they are having problems managing their finances or debts. In that instance, they may be better off taking independent financial advice and/or finding out more about debt management solutions.
Sources: The Department for Business Innovation & Skills; UK Cards Association
Carol Finch - Carol Finch is the Topic Editor for Retirement Planning, Budgeting, E-Commerce & Technical/Business Writing on Suite101.
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