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The good, bad and ugly of credit cards

Deepak Shenoy

Credit card debt puts microfinance companies to shame, with interest rates upwards of 30% per annum. They would probably cut off their right arm before going down to the "usurious" 25% that MFIs supposedly charge, though in all fairness, credit card default rates are very high.

The problem though isn't just the high rate of interest; it's the lack of customer understanding of the product, the nickel-and-dime fees that gets added, and the product structure that, like an expired drug, makes it potentially lethal after month one. Let me explain.

Credit cards aren't necessarily "credit"; if you just got yourself a shiny new piece of plastic, you can buy something worth Rs. 25,000 today on a "card swipe" and get between 20 and 50 days to pay back the money, depending on when your next statement's "due date" is. This, for you, is interest-free; meaning, you pay the bank just 25,000, nothing more.

The statement, though, tells you that you can choose to pay just Rs. 1,250 (5%) as a "minimum". Wow, you think. The impression is that you can just pay back the remaining with a little interest over the next few months.

Unfortunately, at 36% interest, if you pay the minimum (with a floor of Rs. 200), you will take 9 years and six months to pay back the money. "Few" turns out to be "Phew!".

Now comes the poison structure. If you pay the minimum, or indeed, anything less than the total amount due, you get charged interest for further purchases immediately. No interest-free period. This is the part that's really noxious - that the product morphs from a flexible way to pay into the most expensive debt available.

And there are ways around it - banks are happy to move large outstandings to personal loans at a much lower rate (of around 20-25%). If you have multiple cards, you are probably aware of "balance transfer" offers that let one card pay off the other one's balance, with a much lower interest rate. (Gone, unfortunately, are days when such balance transfers were free).

Importantly, if you have other assets (like a fixed deposit, a fully paid up car, shares or gold), you can get yourself an "overdraft" account from a bank. An OD is simply a loan available for how much ever you want up to the overdraft limit - and you get charged interest only for the time that you use it. The difference between that and credit cards is the substantially lower interest rate for ODs. As a concrete example, HDFC Bank offers an overdraft against a fixed deposit at 2% greater than your deposit rate, available on demand. Get an OD and pay off the credit card - you'll pay less in interest.

If you're paying anything less than the full outstanding balance every month, consider an alternative that will give you the credit at a much lower cost. If you're a chronic under-repayer, you probably have a debt problem you must address before it gets out of hand. Easy access to credit doesn't necessarily mean it's the right place for you to borrow.

But cards are good, you think; after all, they give you money interest-free for the first month, if you have paid back in full? It's interest-free for you, but the merchant who sold you the LED TV pays the bank upto 2% of your purchase value. They make their money anyhow!

The fees that cards charge can feel excessive. There are joining fees, annual charges and interest, which will attract an additional 10.3% service tax and cess. If you pay even a day late, you will get hit by a late payment charge along with interest, which can add up to Rs. 1000. The solution: pay early. Most banks now offer online payment through netbanking, even if your account is with another bank. Paying by this method sorts out the problem of cheques not getting cashed in time - a method used by certain banks to ensure they can maximise fees. After all, not all of us look at our credit card statements that closely.

Other fee generation schemes include selling you insurance or other products, sometimes with the caveat that you will enjoy benefits for a while for free, but after some time you get charged if you don't cancel. In 2001, Citibank's attempts to do this were exposed in print. Other forms of fee-gouging include asking you to subscribe to complex pre-paid packages, that don't necessarily work to your benefit.

Drawing cash from an ATM with a credit card attracts interest instantly - and it's easy to see why; there is no merchant paying the bank the 2% for the transaction, so you will pay.

But banks are usually happy to help reverse some of these charges, or soothe them down somewhat. If you're willing to listen to hold music for a while, nickel-and-dime charges are easily sorted out.

An additional plus on credit cards is rewards - you can get some money back, usually about 0.5%, from the transactions you do on the card, either as reward points, cash-back, air-miles, gift vouchers or discounts. This may not seem like much, but consider that a person spending Rs. 30,000 per month on a card and paying it back in full will earn back about Rs. 2,000 in a year. Sometimes, certain restaurants or retailers will offer additional discounts if you use a certain card, or let you make interest free payments instead of a lumpsum - especially during Diwali. Using this lets you make some additional income - that Rs. 100,000 LED TV paid over twelve months gives you 1,600 extra rupees, at just the 3.5% savings account interest rate. (Yes, one might say you can get this as a further discount on the TV. Nowadays, though, TV manufacturers like Samsung will make a direct deal with the bank, so the retailer sees no reason to give you that discount. )

Finally, a word of caution: Being tiny, cards can be stolen or fraudulently used. You need to report a loss, or any strange transaction, immediately - banks will usually help sort out the situation, and you do have the ability to file disputes with bank officials, the RBI or in the courts. Using a card online comes with further security issues - what if someone just finds out your credit card details? Visa and Master card, the largest card intermediaries, have an online verification process that asks you for a second and special password for each online transaction, a password known only to you. Ensure you don't write this on the card - or the PIN number.

Credit cards are a convenient payment method, as long as you don't use them for debt. There are better, cheaper ways to access debt; the powerful part of the system is the "card" - the convenience of not having to fight with store owners for change, the ability to buy a big ticket item without notes bulging out of your pockets, and the piece of your transaction that you get back as rewards which you wouldn't see otherwise. And in an emergency, credit cards give you access to money for a while until you set up access to cheaper finance.

Deepak Shenoy trades the Indian markets and writes at Capital Mind. He's also working on an upcoming stock market education site. You can reach him at deepakshenoy@gmail.com or@deepakshenoy.