It makes logical sense that consumers should have the power to choose how their payments apply to credit card debt. Of course, some must go towards paying interest charges if a balance is carried, but the rest of the payment should be applied to the debt with the highest interest rate, right? That would clearly be in the best interest of the consumer. Unfortunately, that's not how it works in the credit world. Hidden deep in the dark shadows of your credit card's terms and conditions, there is a section known as the "Payment Allocation Provision" - a credit card company's best friend. Since you probably don't have your credit card agreement readily available, it might read something like this:
The provision essentially says that credit card companies will apply your payments in whatever way makes them the most money. After all, they are in the business to make a profit and provide the greatest possible return for their shareholders. You shouldn't expect anything less. And even though the Federal Reserve Board has targeted this practice in their newly proposed rules under the Federal Trade Commission Act, it's likely not going anywhere in the near future. The credit card companies and their lobbyists are currently working hard in Washington to make sure of it.
So how does the provision actually work in favor of the credit card issuer? Suppose you have a balance of $1,000 at a 0% introductory rate and a balance of $1,000 at the normal interest rate of 15.99%. If you make a payment of $500, it will first be applied to any accrued interest on the balance carried at 15.99%, and then the remainder of the payment will usually go towards paying down the balance at 0%. The principal balance at 15.99% will not be reduced at all until the $1,000 balance at 0% is completely paid off. Therefore, the credit card company will continue to make additional money off the balance at a higher interest rate for as long as possible. Meanwhile consumers pay the ultimate price and continue to grow deeper and deeper in debt.
In early May the Fed issued several new proposals designed to protect consumers from billing techniques such as those enabled by the payment allocation provision. One of the proposed actions would require credit card issuers to use a portion of each credit card payment to pay down high-rate balances instead of only applying the payment to debt associated with the lowest interest rate. This is a definite move in the right direction, but shouldn't consumers have the ability to choose how all their hard-earned cash is allocated to pay down credit card debt? The public comment period has unfortunately ended; however, a record-breaking 56,000 submissions were received in response to the proposed rule changes. Federal regulators are currently evaluating the comments before issuing a final ruling, so it could be several months before a statement is released. Let's hope they do what's in the best interest of the consumer.
