That incredibly convenient piece of plastic could ruin you financially. Sanjay Matai explains exactly how interest is charged on your credit card.
Credit cards have become very common and their use has seen exponential growth in the recent years. There are several reasons for this:
- They are a safe and convenient option to cash
- Many establishments allow the use of credit cards
- They are very useful in emergencies
- Discounts, promotional offers and reward points are on offer
- In case of a temporary lack of funds, one can still buy what one needs and pay later in convenient instalments
- Credit card bills can be used as a proof of purchase to get replacement or compensation for defective goods, in case the original receipt is lost
- These bills are an easy guide to assessing one's spending pattern and can help in budgeting in future
But, thanks to the interest charged, the credit on one's card can work out to be extremely expensive. Most credit cards offer an 'interest-free' credit period. Depending on the date of purchase, this can vary between 20 to 50 days.
Say the bank generates the bill for purchases made between 12 November and 11 December, which is due on 30 December. If the entire amount due is cleared on or before the due date, no interest is charged. Therefore, if the purchase was on 11 December, one enjoys 20 days of free credit; if the purchase was on 12 November, the free credit period works out to almost 50 days.
But once the due date is over, if all dues have not been cleared in full, the interest clause becomes effective. This can work out to quite a hefty amount, because of the manner in which the interest is charged.
- The interest mentioned - usually between 1.99 per cent and 2.95 per cent - is the 'per month' interest rate. On an annualised basis, this works out to an astronomical 24 per cent to 36 per cent.
- The interest starts from the date of purchase, not from the due date. This means you do not get any interest-free credit period.
- All future purchases also attract interest charges from the date of purchase.
- Interest is also payable on any unpaid interest; one has to pay interest on interest.
An example will help to understand the calculations better. Given below are statements for two months. The first month's dues are not cleared in full, so interest becomes applicable, which is reflected in the second month's statement.
|Statement date: 1 Oct|
|Date ||Transaction details || |
|Sept 10 || || |
|Sept 21 || || |
|TOTAL || |
|Total Amount Due: Rs2,700|
|Minimum Amount Due: Rs135|
|Statement date: 1 Nov|
|Date ||Transaction details ||Amount (Rs)|
|Oct 4 ||Jet Airways ||6,500.00|
|Oct 12 ||Payment received ||1,500.00|
|Nov 1 ||Interest charges ||191.31|
|TOTAL ||7,891.31 |
|Total Amount Due: Rs7,891.31|
|Minimum Amount Due: Rs394.57|
(Note: The minimum amount due is usually 5 per cent of the total amount due or Rs100, whichever is higher.)
The interest rate has been assumed at 1.99 per cent per month. Accordingly, the total interest works out to Rs191.31, as detailed below:
On the transaction dated Sept 10, from transaction date up to statement date: Oct 1
Rs1,email@example.com% x 22/30 days = Rs21.89
On the transaction dated Sept 21, from transaction date up to statement date: Oct 1
Rs1,firstname.lastname@example.org% x 11/30 days = Rs8.76
On the total amount due from statement date: Oct 1, up to part payment date: Oct 12
Rs2,email@example.com% x 11/30 days = Rs19.70
On the balance from part payment date: Oct 12, up to next statement date: Nov 1
Rs1,firstname.lastname@example.org% x 20/30 days = Rs15.92
On the fresh purchase dated Oct 4, up to statement date: Nov 1
Rs6,email@example.com% x 29/30 days = Rs125.04
If the entire amount due, Rs7,891.31, is paid on the due date: Nov 1, the effective cost or internal rate of return (IRR) works out to an astonishing 28 per cent, though in absolute terms the monthly interest may be just a few hundred or thousand rupees. This creates a perception of cheap finance, which actually is not true.
The banks, on their part, say they are not unjustified or being unreasonable in the manner in which the interest is levied or in charging high interest rates on credit card balances, as these essentially constitute unsecured credit.
But the fact is that the way the interest rates are advertised - 1.99 per cent or 2.95 per cent - they appear to be low and tend to mislead consumers. But this problem has been addressed in recent RBI guidelines to the banks, which have been directed to henceforth mention only the annual percentage rate.
One should also appreciate the fact that the returns from the amounts lying in bank fixed deposits or other investment avenues (except, maybe, in shares or mutual funds) will not match the kind of interest charges one is paying on a credit card. It would be prudent, therefore, to encash one's investments, if any, and pay-off outstanding credit card dues.
As credit on a credit card is very expensive, it is important to clearoutstanding amounts on or before the due date. A little bit of thought and care can help one avoid paying high costs of credit cards.
also see :
Beware, card users !