A Costly Loophole In the Credit CARD Act

The Credit Card Accountability, Responsibility and Disclosure Act banned many of the industry’s most abusive fees and practices when it went into effect last winter.

But there’s a loophole in the new regulations that really bugs us.

In the past, credit cards routinely applied payments to that portion of your balance being charged the lowest interest rate.

If, for example, you took out a cash advance with a 29.99% interest rate but were charged only 8.99% interest on purchases, the credit card company would apply your payment to the balance with 8.99%.

That way, they could keep charging you 29.99% on as big a chunk of money as possible for as long as they could, making it harder for you to pay down your debt.

The Credit CARD Act was widely praised for reversing that and forcing credit cards to apply payments to the most expensive debt first.

But the new regulations don’t really go that far.

The rules have left many cardholders wondering how their payments are being credited, and provided no relief for those who need it most — customers who can only afford to make the minimum payment each month.

Here’s what the law says:

Upon receipt of a payment from a cardholder, the card issuer shall apply amounts in excess of the minimum payment amount first to the card balance bearing the highest rate of interest, and then to each successive balance bearing the next highest rate of interest, until the payment is exhausted.

That means the portion of your minimum payment that goes toward reducing your debt can still be applied against the balance with the lowest interest rate.

Discover and Bank of America told us that that’s exactly what they’re doing. Chase (true to form) declined to comment. But you know it’s taking advantage of the loophole, too.

The only way to reduce your high-interest debt is to remit more than the minimum payment.

Using our previous example, let’s say your minimum payment is $300 a month, with $100 going to interest and the remaining $200 to reducing your debt.

Banks can still apply that $200 to the balance that charges 8.99% interest.

If that’s all you send in, this part of the Credit CARD Act hasn’t made it any easier for you to get out of debt.

If you write a check for $400, only the $100 “in excess of the minimum payment” would be used to pay down that portion of your debt charging 29.99%.

While that’s an improvement, most of your payment still went towards reducing your least costly debt.

We think Congress should have demanded that all payments be credited to the most costly portion of a cardholder’s balance.

But it’s hard to do the right thing when the credit cards, and all of their highly paid lobbyists, are fighting to do the wrong thing.