Credit card reform could go further

When you pay your credit card, the payment will now be applied to the debt with the higher rate first.

Sounds like common sense but it took a government to step in and force these reforms.

Current common practice across the industry is to accept credit card repayment for the debt with the lowest interest rate first, leaving the higher interest balance to attract further interest charges.

It's a real problem for cardholders who take up balance transfer offers, as often the discrepancy between the two rates can be as much as 18%.

It's also a real problem for card issuers because if those offers prove to be unsustainable under the new laws, you can bet they will become a thing of the past.

According to Canstar Cannex's credit card specialist, Peter Arnold, when the US reformed its credit card laws, interest rates moved up for everyone, as lenders could no longer charge higher interest on accounts in default.

"Put a blanket ban on a particular type of fee [or in this case a hierarchy of payments] and lenders will make it up in other areas," says Arnold.

This ruling on the hierarchy of payments, along with no fees for going over your limit unless you accept the option (a 10% buffer to go above your maximum limit is available at your lender's discretion), will only apply to new credit card contracts entered into after July 1, 2012.

Other credit card reforms which apply to both existing and new cards include:

• Contracts to state a warning of how long it will take to pay off your debt if you only pay the minimum monthly repayments.
• Card providers not allowed to invite customers to increase their credit limits (customers will have to apply for this).

While the regulations have tackled some of the important issues, credit cards will continue to be a problem until the "pay it later" mentality is lost.

It's great that credit card statements will come with a financial health warning, i.e. stick to minimum repayments on your debt at X%, and not only will you pay $Y in interest but it will take you Z years to clear.

But it would have been better if the reforms went one step further and set a higher minimum repayment benchmark or, at the very least, a tiered minimum repayment schedule that was aligned to the interest rate of the card - the higher the interest rate the higher the minimum repayment.

At one stage minimum monthly repayments were set at 5% of the outstanding balance, but over several years banks have whittled them down from 3% to as low as 1.5% or $25 whichever is the greater.

Reward cards didn't get a mention in the reforms even though in the wrong hands they are a big issue.

"No one should have to pay 20% interest every month when they're clearly not paying off their debt each month during the interest-free period," says Arnold.

He suggests that specific guidelines on switching people who consistently pay the minimum repayment on their reward cards to a lower rate card could work.

ANZ may have it right with their Balance Visa by only allocating reward points for repayments rather than purchases.

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