What is a credit card payment hierarchy?

How well do you know the credit card in your wallet? Most cards come with many terms, conditions and definitions that it takes time to truly understand.

The Payment Hierarchy is one of your card’s definitions that is worth taking the time to understand, and recent measures have been made to simplify how it works.

To get you up to speed and let you know how the changes benefit you, we’ve created this handy summary.

How would you describe a Payment Hierarchy?

Most people have a balance on their credit card – money owed to the bank. This can be made up of a range of payment types:

  • The principal (the original bit you borrowed)
  • Any balance you transferred from another card or account
  • Any late fees
  • Interest
  • Cash advances

When you make a repayment to your overall card debt, the Payment Hierarchy tells the bank which parts to pay off first.

Current Payment Hierarchies

For credit card accounts opened on or after 1 July 2012, Australian Banking Reforms mandate that banks allocate your repayments to the portion of the closing balance which attracts the highest interest rate first.

And then to the portion of the closing balance account which attracts the next highest interest rate, and so on.

This is great for the consumer, as they are likely to pay less interest over time. In some cases, a balance transfer with a 0% per annum introductory offer may have been partly negated by the balance transfer being paid off first, meaning other credit card purchases (like that new car!) still accrue interest until the entire balance transfer was paid off.

It’s very important to note that accounts opened before 1 July 2012 may have different payment hierarchies noted in the contract. If you have an outstanding balance on a credit card obtained before this date, check your payment hierarchy to ensure you’re getting the best deal.

Paying off your credit card using the payment hierarchy – an example

Here’s an example for illustrative purposes only, where the credit cardholder has a credit card balance with the following components:

  • Balance transfer special offer rate of 0% per annum for 6 months
  • Cash advance rate of 20% per annum
  • Purchase rate of 19% per annum

Based on the legislated payment hierarchy, the portion of the balance with the highest interest rate is paid off first, thus payment would be allocated as follows:

  1. Cash advance (highest interest rate of 20% p.a. – this balance would be paid off first)
  2. Purchase (interest rate of 19% p.a. – this balance would be paid off second)
  3. Balance transfer (interest rate of 0% p.a. – this balance would be paid off third)

Let’s now assume you have an outstanding credit card debt of $240, made up of:

  • Cash advance – $100
  • Purchase – $20
  • Balance transfer – $120

If you decide to pay two separate amounts of $110 towards the balance, here’s how the payment hierarchy allocates repayments: