Banks are now trying to give credit cards a makeover! Button and light controls to choose if you want to utilise reward points, security measures prompting you to enter a pin and even smart phone aligned credit card technology is being researched aggressively to make the plastic cards obsolete.
However the scenario in terms of utilising credit cards seems to have changed in India compared to yesteryears. In recent times credit card usage has seen a significant decline compared to its rapid growth especially between 2005-2008. After that due to the recent global financial crisis the credit card usage took a dip replaced by a consistent rise in debit card usage.
Credit cards can be a smart tool if made use of judiciously especially when you want to ramp up a good credit score. Here are some pitfalls you need to look out for in order to utilize your credit card to the optimum.
Understanding the due date and the "interest free" period
The 'interest free' period should not be taken for granted. To understand the interest free credit period in better light let's take the example of Ashish. His credit card provided him interest free credit for upto 55 days. He however had the good sense to know that this did not hold true in the case of cash withdrawals as the interest rate meter starts ticking from the moment cash is withdrawn not to mention a withdrawal charge of around 3-4%.
Though he refrained from withdrawing cash using his credit card he however did not read the fine print thoroughly and got confused with why his interest free period varied with every purchase!
After paying up the interest debating with the credit card company he learnt the hard way that he does not get a 55 day interest free period for every purchase he makes!
It only means that the maximum number of days you won't be charged interest for a new purchase is 55 days and this is tied to the day of the payment cycle (billing period) you make your purchase.
Ashish's credit card statement starts on the 1st of every month and ends on the 30th of every month. If he had up to 55 days interest free, his credit card bill will be due on the 25th of the next month.
So for instance let's consider:
1st October - first day of the credit card statement
31st October - last day of the credit card statement
24th November- the day the October credit card bill is due
This means that there is a total of 55 days from the 1st of October including the day his bill is due.
Now let's say he made a purchase of Rs. 100 on the 1st of Oct. No interest will be charged on the amount of the purchase up to, and including, the 24th of Nov. So, he will get 55 days interest free on the purchase billed to his credit card on the 1st of Oct.
Here is what happens in other scenarios.
If Ashish makes a purchase of Rs.150 on the 20th of Oct, still no interest will get charged as including 24th of Nov from the date of purchase he has a 35 days interest free period.
However, if Ashish makes a purchase of Rs.200 on Nov 22, he still will not get charged interest as he would get 2 days of interest free purchase after which his interest meter will kick in and reflect in his next bill. Ashish can prevent this by making a full payment for all the purchases made in this billing cycle. Instead if Ashish merely stuck with making minimum payments, then things can get tricky for him.
Tip: To observe of interest rate is being charged for any of the recent purchases you made towards the end of a billing cycle, always check your current credit card statement online as opposed to the last credit card statement. This will alert you of any accumulating interest and enable you to close the dues quickly before you end up paying a hefty interest charge.
Minimum payment and what it implies
Your credit card company normally fixes around 5-20% of the total payment due as the minimum payment to be paid up before the due date specified in your credit card statement. If you do not pay even the minimum amount then late charges will also be added along with the interest.
If you opt to pay the minimum amount due, the unpaid amount is carried forward to the next billing cycle and so on, under revolving credit facility. What you need to note here is that, any fresh purchases will not enjoy an interest free period i.e. you start paying interest from the day on which you make a purchase.
This will continue till the total amount due has been paid for. Also even if you pay the minimum amount due, interest will be charged on the total amount due.
Let us take consider the example one Deepthi Thakur who used her credit card extensively, usually more than 80% of her credit limit of Rs.1.5 L.
She had the habit of paying up only the minimum amount due promptly before the due date. Let us take one instance, where her expenses on the card amounted to Rs.1 L and calculate how much interest she had to eventually shell out by the time she repaid the amount due in full, by paying only the minimum amount due. Remember, this is calculated without taking into account her future expenses on the card, assuming she does not use it after this particular billing cycle.
|Expenses on the card||Minimum amount due 5% of Rs.1L||Annualized Interest Rate||Total Interest Repaid||Total Cash Outflow|
|Rs. 1 L||Rs.5,000||38.00%||Rs. 1.62 L||Rs. 2.62 L|
Credit card and credit limit - its impact on credit score
One of most effective ways to utilise your credit card is to plan your spending and repayment with them in a manner which boosts your credit score. Never exceeding 40% of your credit limit has a very beneficial effect on your credit score. This shows your credit limit is high but you have not burnt it up and have plenty in reserve. This logic helps you attain a much higher credit score. Remember bad usage of your credit card and plummet your credit score to dark depths. Your chances of getting a loan in future will become slim or will come with a very high interest rate attached to it.
In summary, here is a list of Dos and Don't s
|Make wise decisions about purchasing items you need versus those you simply want. It is important to distinguish between the two.||Use your credit card to make everyday purchases like food, clothing, and petrol. Using your credit card as a substitute for cash will land you in unnecessary debt.|
|Pay on time, within the due date. Consecutive missed payments will result in a poor credit score.||Get into the habit of making minimum-only payments. Making only the minimum payment each month increases the amount of time it will take to pay off your debt.|
|Stay within 30-40% of your credit limit.||Use your credit card to buy things you can't afford.|
|Read your credit card statement carefully.||Withdraw cash from an ATM using your credit card. Not only will you be charged a withdrawal fee, but the interest will levied from the moment the cash is withdrawn.|
The author is Head, Content& Research at BankBazaar.com, an online marketplace for personal loans, home loans and car loans.