Dangers of credit cards!

The one thing that he forgot was to be educated about the different features this card offered, read the agreement and understand the cost of using each of these features. The card offered a grace period or free credit period of 30 days. Thereafter, it charged 3.5 percent interest on the outstanding amount due. Mr. Amit was delighted to get the extra liquidity the credit card offered and spent Rs. 10,000/- on clothes. He could pay the money back only after 120 days. Now, in addition to Rs. 10,000/- that he spent, Mr. Amit was charged interest on Rs. 10,000/-, i.e. Rs. 86/-.

Credit cards or plastic money is now a common mode of payment. The basic concept of credit cards works as – “spend now and pay later!” It is important to understand the spending power that your card holds and hence to use it intelligently. It is easy to fall into a debt trap if you do not use your card wisely. Here are a few points you should keep in mind when you use your credit card: –

Expenses involved in holding and using a credit card: –

A credit card company approached Mr. Amit and convinced him that he would really benefit by owning the credit card that the company had to offer – status in society, liquidity, ease of payment, low risk of theft, international acceptability, better record keeping – he could have it all!

The one thing that he forgot was to be educated about the different features this card offered, read the agreement and understand the cost of using each of these features. The card offered a grace period or free credit period of 30 days. Thereafter, it charged 3.5 percent interest on the outstanding amount due. Mr. Amit was delighted to get the extra liquidity the credit card offered and spent Rs. 10,000/- on clothes. He could pay the money back only after 120 days. Now, in addition to Rs. 10,000/- that he spent, Mr. Amit was charged interest on Rs. 10,000/-, i.e. Rs. 86/-.

Calculation of Interest amount:

3.5 * 10,000/100 =Rs.350 per month.

Interest paid  =350*90/365 =Rs. 86/-

Were the expenses on the card worth the extra amount he paid towards the interest or could he just have waited till he actually had the money to incur these costs?

Credit cards extend one’s current spending power and tempt people to get into unnecessary expenses.

Another scheme that the card offered is that of minimum payments to keep the card active. Mr. Amit had to make a minimum payment of Rs. 1000/- every month. Assume that he spent another Rs. 20,000/- the next month and paid that back too in the fourth month. If Mr. Amit only made minimum payments on his credit card, he would incur a total interest cost of Rs. 187/- by the fourth month.

Calculation of Interest amount: –

Interest payable in Month 1: NIL

Interest payable in Month 2:  9,000*3.5/100 =315 p.a., i.e. Rs. 26/- per month

Interest payable in Month 3: 28,000*3.5/100 =980 p.a., i.e. Rs 82/- per month

Interest payable in Month 4:  27000* 3.5/100 =945 p.a., i.e. Rs.79/- per month

Making only minimum payments on credit cards can be dangerous. It is advisable to make full payment on your credit card bill within the free credit period to avoid interest costs.

Mr. Amit’s credit card company also charged him Rs.2500/- in annual fees. This is another cost that he would have to incur just for holding the credit card.

The credit card company charged him 2.5 percent fuel surcharge. So for the convenience of using his credit card at the petrol pump, he was also incurring an additional cost. It seems to be negligible  – but combined over a period of time, the amount adds up to a considerable expense.

The card also had a lifetime balance transfer scheme. That means that Mr. Amit could transfer his outstanding credit balance from another card onto this new card! This was great news as he could get additional grace period to make payments on the outstanding amount, which was an immediate relief for him. However, this also came with a charge – 1 percent for first 12 months, i.e. 12 percent p.a., and 2 percent for the remaining period of outstanding loan, i.e. 24 percent p.a.

There could be other hidden charges that a credit card company may charge like over the limit fees, transaction fees etc. Be aware of all these charges before using a credit card.

Rigorous debt collection techniques

Credit card companies sometimes indulge in aggressive debt collection practices. Don’t be surprised if you get calls at odd hours, have surprise visitors at office and have to face embarrassment in front of your guests – debt collectors will get to you at any time! Things are changing today and companies are discouraged from resorting to such techniques. However, it is still important to remember that defaulters are at the mercy of credit card companies.