MBNA first to react as negative payment allocation is banned

THE rule that credit card holder's monthly payments pay off their least expensive debt first is due to end in January 2011 thanks to a deal made between the last Labour government and the credit card industry.

MBNA, however, are one step ahead, declaring a week ago that they will be changing their payment allocation system this September.

As of today, Virgin Money, whose credit card business is run by MBNA, also confirmed that they will be bringing the rule in early.

For years providers have been sneakily manipulating a little known part of card terms and conditions called the allocation of payments clause to suit their own needs.

Allocation of payments governs how money which pays off a card debt is applied to balances accruing interest at different rates.

Card providers often pay off the lowest interest rates first, leaving balances with high rates stacking up costs for the cardholder.

As of January, however, this 'low to high' policy, also known as negative order of payments, will be banned.

'We thought of it first'

The Nationwide credit card range and Saga's credit card have used a positive order of payments system for some time.

Nonetheless, MBNA executive Ian O'Doherty claims that the plans to make this change available for MBNA customers were in the works long before the government's new laws were decided.

With similar modesty Virgin's spokesperson Grant Bather said that the provider's, "aim is to make everyone who is a Virgin Money credit card customer better off and we hope this change goes some way to achieving that."

Whether this is true or the new policy is a direct reaction to the upcoming laws remains in question, although it makes little difference to the millions of MBNA and Virgin customers who will benefit from the change.

How much benefit?

But how much will they benefit?

Let's say a credit cardholder has a credit card balance made up of:

• £2000 purchases (interest at 15% p.a.)
• £500 cash advances (interest at 25% p.a.)

If the cardholder pays back in five monthly instalments of £500 with a negative order of payments (low to high) that's five months of accruing interest at 25% p.a. With a positive order (high to low) it's only one month.

That's quite a difference in terms of the actual interest the cardholder could expect to pay.

In addition, 'trapping' balances accruing interest at a high rate behind 0% or lower rate balances has always been a popular tactic for credit card providers to maximise card charges for unsuspecting consumers.

By stipulating that certain charges must be paid off before others, interest can accumulate to an alarming extent.

balance transfer cards are particularly susceptible to this, especially those which also offer shorter interest free spending periods, as the provider prioritises the balance transfer amount.

This means that any purchases on the card, which usually have a higher interest rate than balance transfers, will be trapped until the balance transfer is repaid.

In the meantime, this amount will be ever growing, as the interest rate will still apply.

Nationwide estimates that customers making a balance transfer build up an average of £224 in extra charges a year when they fall prey to this trick.

The new laws

A recent agreement between the Credit and Store Card Review and the UK Cards Association saw many unreasonable hidden charges and tricks eliminated.

The new laws will ultimately give consumers fairer rights with their credit cards and more room to negotiate, leaving them less likely to fall into irreparable debt.

Negative order of payments and trapped debt will become things of the past with this new scheme. From January next year, the highest amount will always be paid off first.

Customers should be careful, however, to not get ahead of themselves. Although the modifications are being discussed and decided, the changing policy is yet to be applied by all credit card providers and it remains unclear whether all providers will be able to meet the January deadline.

Consumers should ensure they know exactly when their provider will be making the change before relying on it being in place.