Credit card – A friend or a foe?

A credit card gives individuals a pre-approved loan limit for using at merchant outlet for consumption and withdrawing cash from ATM outlets. The credit card follows a monthly settlement system.

How it works

Suppose the billing date for the credit card is the 14th day of every month, known as statement date. How this credit cycle works - using the current month statement that is billed on statement date, 14th April, 2019. Thereafter most banks provide a period of 20 days to pay the bill, known as payment due date.

The consumption/ use of credit card from March 15, 2019 to April 14 April, 2019 will get billed in this cycle (that is, April 14, 2019). The payment due date will be 20 days after the statement date (that is, May 4, 2019). So, you have to pay the bill for what you consumed starting of the billing period (that is, March 15). There is a 30-days period during two billing dates and another 20-days grace period for making the payment. The concept is based on use now, pay later.

If we use the card up to the available credit limit and pay up on time, then it will not attract any interest nor it will levy any late payment bank charges. Technically speaking the bank provides a free credit or loan for a period of 50 days. Credit card is not bad, in fact it is good. It is like a helpful friend.

Please note that withdrawing cash from ATM does not have any free credit period and interest charges starts to apply immediately.

Then why do people have horror stories related with credit cards? There are two reasons for the mis-use of the weapon. The first being the desire of instant gratification, spending makes people happy; the urge to satiate the desire beats the logic of how are they going to repay the amount on time. Second, getting caught in the trap of "minimum amount due" or not paying in full.

The debt-trap maze

On or before the due date if the complete amount is not paid then the bank starts to charge interest rates at the rate of 2.65% per month compounding, resulting in an annual rate of 36% per annum. Assuming that the statement date on February 14, 2019 had zero outstanding and all your purchases happened in the last billing period (February 14 to March 14 2019). You missed paying the entire amount that was outstanding on April 4, 2019. You paid only the minimum amount due (5% of the total outstanding). In such a case your credit period gets nullified and the bank starts charging interest from the date of use for the exact number of days until you make the full payment.

As stated, the bank charges an interest rate of 36% per annum and also late payment fees. The late payment fee is generally charged slab-wise (if your outstanding is less than Rs 10,000 then it will be Rs 350, between Rs 10,000 to 20,000 charges could be Rs 500 and over Rs 20,000 it charges Rs 600. This it may vary from bank to bank).

Assume you have a credit card outstanding loan of Rs 1,00,000 and you wish to pay only Rs 5,000 per month, you will clear the said outstanding in 33 months, paying approximately Rs 1,63,000 approximately, including bank late payment fees.

Credit card is actually not bad, but the way you use it decides whether it is good or bad. So be money smart, use the double-edged sword to your advantage and make it your friend.

The writer is founder and CEO, FINCART