Credit Card 'Negative Payment Hierarchy' is Bad News for Consumers

By: Jaime Concha
27-Mar-2010

When used as a source of short-term advance cash, with the intention to repay the amount in full as soon as possible, credit cards are a useful form of financial support.  However, with credit and store cards becoming increasingly commonplace in the UK, consumers are constantly under a huge amount of pressure from credit card companies to spend on their cards on an everyday basis and accumulate debt irresponsibly.  The pervasive nature of credit cards can be seen in the huge number of card holders; in 2009, there were 30.3 million credit card holders holding 58 million credit cards, according to figures from the UK Cards Association. 

However out of control spending is not the only cause for concern.  In what is called a culture of 'negative payment hierarchies', credit card providers tend to reclaim the cheapest debt first, leaving the more expensive, high-interest debts racking up more interest on cardholders' balances. This practice incurs additional interest totalling 300 million GBP a year for consumers. In fact, around 80% of credit cards (178 out of 225) allocate debt repayment in this way.

According to Defaqto, the independent financial research company, companies normally expect consumers to pay back credit card charges in the following order (lowest to highest interest):

1.   Default Charges (for missing a payment or paying late)

2.   Promotional balance transfers

3.   Promotional purchases

4.   Purchases, balance transfers and other charges

5.   Cash withdrawals

In addition to this, credit card debt is most likely to increase to unmanageable levels when consumers that only pay the minimum amount due on their balance.  Most of the time, consumers aren't informed that this is the most inefficient, expensive way of paying back debt. In fact, paying only the minimum amount due each month is so inefficient that someone who pays a minimum 2% monthly repayment on a card with a 1,000 GBP balance would take around 37 years to completely repay it.

"Guidance on increasing minimum monthly repayments to ensure credit card debt is paid off more quickly is important," said Peter Harrison, credit card expert from moneysupermarket.com. "Consumers need to understand the implications of paying just the minimum payment on their credit cards."

Teresa Prichard from the Citizen Advice Bureau feels that it is unfair for credit card companies to do this. "The level of minimum payments has not always enabled consumers to keep up with the interest, let alone repay some of their borrowing," she says. "And it has not been fair for the companies to decide whether to allocate payments to the cheapest or most expensive borrowing on the card."

If you are unsure in what order you are  credit card debt is currently being paid back
The importance of education and asking your bank on these issues is key to not fall into the debt trap. The Government is drafting a plan to increase fair play in banks, forcing them to act in the consumer's best interest.