Owning a Credit card can be financially empowering. However, with great power comes great responsibility and there are aspects to owning a Credit Card that you must always be aware of. This way, you can make optimum use of your available credit and not risk falling into a debt trap.
Timely full repayment versus minimum payments
As a Credit Card holder you have the option to either repay your dues entirely or pay a minimum stipulated amount every month. The interest on your outstanding Credit Card amount is compounded based on your daily balance. The minimum due amount is generally 5% of the balance outstanding as calculated on statement date.
By paying only the minimum due amount you will not be offered any interest free credit period. You will be charged heavy interest as well. (More on that below). The interest component keeps accumulating till the dues are settled making the cost of ownership very high.
2. Be aware of Credit Card penalties
If you have been late in making payments for your Credit Card due amount, the banks are well within their right to charge you a penalty. The penalty varies from bank to bank depending on the outstanding amount and the Credit Card type.
One leading bank, for example, charges a penalty fee of Rs. 400 for statement balance up to Rs. 5,000, Rs. 500 for a balance between Rs. 5,000 to Rs. 10,000, and Rs. 700 if the balance exceeds Rs. 20,000.
So, not only are you paying a high interest rate, but also a late payment penalty for not repaying dues timely.
Additional Reading: How Late Credit Card Payments Affect You
3. Do not overlook annual charges
Banks levy annual charges or annual maintenance charges for utilization of Credit Card services. The exact amount of annual charges levied varies from bank to bank as well as the type of Credit Card you have.
Annual maintenance charges can run into thousands of rupees annually for high-end cards. Often, these charges are waived during the initial years, or if your Credit Card spending exceeds a stipulated limit. As a Credit Card applicant, make sure to compare annual charges before finalising your Credit Card selection.
Additional Reading: Insight On Credit Card Charges
4. Understand the interest rates and billing cycle
Credit Cards have high interest rates ranging from 1.7% to 3.5% per month. This may not sound like a lot, but annually, we’re talking of interest rates between 20% and 40%, which makes Credit Card debt one of the most expensive forms of debt.
Although Credit Cards come with an interest free period, it is not linked to the day of your purchase, but to the card’s billing cycle. So if your card’s billing period starts on the 10th of every month, any purchase you make of the 7th of that month will get you only 3 days as interest-free period instead of the full 45 or 50 days interest-free period.
Timing your Credit Card purchases should be made in accordance with your card’s billing cycle to ensure you take advantage of the maximum possible interest-free period.
5. Credit Cards and their impact on Credit Score
Your Credit Card defaults or nonpayment of dues not only add high interest and penalties, but also negatively affects your Credit Score.
Recently, the Reserve Bank of India issued guidelines wherein banks can levy a penalty and report procrastinators to credit information companies if payments are delayed by more than three days.
Not paying the minimum due amount within 90 days from the due date can mean banks will treat your Credit Card as a non-performing asset (NPA), thereby damaging your Credit Score immensely.
6. Watch your credit utilisation ratio
Your credit utilisation ratio is the amount of available credit that you spend. For example, you may have a Credit Card limit of Rs. 100,000, and you spend Rs. 50,000 every month. This means your CUR is 50%.
Even if you pay your Credit Card bills on time, in the eyes of a credit rating agency you may appear to be a person in frequent need of credit. Essentially, a credit-hungry person.
The ideal CUR, from the perspective of having a healthy impact on your Credit Score, is 20% -30%. If you exceed this limit frequently, you should change tactics. Ask for a higher credit limit, split your spending between multiple Credit Cards, or simply bring your Credit Card spending down to acceptable levels.
If you are a first-time Credit Card holder a Credit Card can be an extremely effective financial tool, as long as you are aware of the finer details including usage etiquette and associated financial charges.
(This article originally appeared on Yahoo! India Finance.)
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