When it comes to credit cards, the argument continues. Some swear by it, some swear at it. That’s understandable. A credit card is a double-edged sword, and people’s perceptions are shaped by their experiences.
Use it wisely and a credit card can offer much convenience and flexibility— cashless shopping, reward points, offers, and best of all - free credit period during which you don’t have to pay for your purchases. But slip up on timely payments, and the plastic can burn a big hole in your pocket. The bottom-line: make the most of your credit cards and use them smartly and by paying the dues in full and on time.
Goodies galore
A credit card carries many goodies. One, it’s easy to use and lets you go shopping without lugging around wads of cash. Dip/swipe of the card in the payment machine, and entering your pass-code discreetly is all it takes to check-out. Next, you earn reward points on using your credit card. These points can be redeemed for various purposes, including paying for purchases online or at merchant outlets, and paying the card’s annual fee. On some cards, there may be no joining fee and the annual fee could also be waived off if your spending exceeds a specified limit. Some banks have issued co-branded credit cards in tie-ups with entities such as oil companies and airlines — this allows users to pay for expenses such as fuel purchases and air tickets using reward points. Some card issuers also allow redemption of reward points into money that is credited to customers’ bank or card accounts. How many reward points you earn on card usage, how they can be used and the conversion ratio of such points for redemption depends on the type of card and its terms and conditions. Besides reward points, some credit cards provide users various offers. These include cashbacks on purchases and discounts on spends at select restaurants, and access to airport lounges and special events. In short, credit cards can bring down your costs and be quite handy.
In addition, credit cards offer users another big plus — an interest-free credit period of about 15-45 days during which you do not have to make payments for purchases made using the card. Say, the latest billing cycle on your credit card is May 20, 2019 to June 19, 2019 — and the payment due date is July 5, 2019. For purchases made on May 20, you can pay after about 45 days and for purchases made on June 19, you get to pay after about 15 days — on July 5.
During this free credit period, the amount stays in your bank account or in other investments, earning interest or returns.
This effectively means that you have borrowed money from the bank free of cost and have deployed it to make money.
If you have more than one credit card with different billing cycles, you can schedule your spends such that you enjoy the maximum credit free periods on the cards.
Now, why would the card-issuing bank be so generous? Banks are not generally known for altruism, no? The catch is that banks know, from their experience of human financial behavior, that a certain proportion of their credit card customers will not settle their dues on time — despite the free credit period. And it is from such customers that the banks extract their pound of flesh and make profit on their credit card business.
Pay punctually
Payment defaults on credit card dues can prove very costly. The exorbitant interest charged on credit card dues — up to 3.5% per month — works out to more than 40% a year. This makes credit card debt among the costliest in the market.
Then, there are late payment charges on payment defaults and the goods and services tax (GST) to add to the woes.
Pay up in full and on time because even part payments can be very costly. Credit cards allow their users ‘revolving credit’ — this means that you can make a minimum payment (usually 5% of the total sum due) by the due date and carry forward the balance to the next billing cycle. It sounds good, but is not. When you opt for the ‘minimum payment’, you kiss goodbye to the free credit period. So, on the bill amount, you get charged interest right from the transaction date, and not just from the due date.
Say, your credit card billing cycle is from April 1 to April 30. You spend ₹10,000 on April 10. The billing date is May 1, the payment is due on May 15 and the minimum payment due is ₹500. You also make purchases of ₹5,000 on May 17.
Minimum payments
If you pay the entire April due of ₹10,000 by May 15, you get free credit period of up to 35 days (April 10 to May 15) and also free credit period on the purchase of ₹5,000 on May 17 in the next billing cycle. But if you make only the minimum payment of ₹500 by May 15, you get charged interest from April 10, and also lose the free credit period on the purchase made in May.
Say, you settle the balance dues of ₹14,500 (₹9,500 plus ₹5,000) on May 25. Interest cost will be calculated as follows: on ₹10,000 from April 10 to May 15, on ₹9,500 from May 15 to May 25 and on ₹5,000 from May 17 to May 25. At 3% a month or 36% per annum, the interest cost works out to about ₹480. Add to this GST at 18% and you will be down by about ₹570.
The minimum payment option can be useful if you face a temporary cash crunch. But if you make a habit of it, you could soon find yourself in a debt trap.
The payment will run into years, with massive interest outgo. Your credit score will also take a knock. A saving grace in paying the minimum due is that you do not get charged late payment fees. You escape the defaulter tag and could face a lesser negative impact on your CIBIL score.
If you do not pay even the minimum due, you will be labelled a defaulter and also pay late payment fees in addition to the interest cost. You could also be charged a higher interest rate when you do not pay even the minimum amount due. You should always strive to pay your dues in full – each time, every time. With credit cards, there is the risk of complacency setting in; some credit card users have a false sense of sufficient money being available for spending even though it is actually only borrowed and has to be repaid.
Be wary of this and restrict spending on the card only to the extent you can pay when the bill arrives.
Avoid cash withdrawals
Lastly, while you are allowed to use your credit card to withdraw cash from ATMs, this is not a good choice. That’s because such cash advances don’t enjoy free credit period and are charged interest at high rates from the date of withdrawal until they are repaid.
Also, a transaction fee is levied on such transaction. Do this only in real emergencies.
