So you went berserk -- shopping, eating, entertaining, all on your credit card.
You're not really to blame -- after all, how often does one get to celebrate a nice, long festive weekend?
But, as the proverbial saying goes, good times have to come to an end. Reality sets in. Mundane tasks clamour for your attention. As will your credit card bill, when it lands on your doorstep.
Now, for the million-dollar question: What if you cannot pay it?
Well, you don't have any option but to 'revolve credit'. This means you pay part of your bill (five percent is the compulsory minimum) now and pay the rest later. It may sound convenient, even good, but remember -- revolving credit is not cool.
Here's why.
Let's assume you've run up a bill of Rs 25,000.
Since you don't have the necessary cash at the moment, you decide to use the revolving credit option and pay five percent of the amount -- Rs 1,250 -- now.
The balance (Rs 23,750) is carried forward and will be added to your next bill.
This is where the good news ends because the bank will charge you an interest of 2.95 percent on the pending amount.
Before you heave a sign of relief, remember this interest is charged on a monthly basis; per year, it works out to a whopping 35.4 percent!
At 2.95 percent per month, your interest on Rs 23,750 works out to Rs 700 a month.
So, if you don't use your card in the coming month, your next credit card bill will be Rs 24,450 (Rs 700 + Rs 23,750).
However, in that month, you happen to go out for dinner and the bill comes to Rs 1,000. You pay for it with your credit card.
Unfortunately, you are no longer enjoying the benefit of 'free credit'.
Earlier, you spent money through your credit card and paid up when the bill came at the end of the month.
From the time you spent the money till the time you paid the bill, you were enjoying free credit; when the bill came, you paid just what you spent (You do have to pay the annual fee as your cost for owning a credit card, but that's a minimal amount. There are, of course, reward points that work to your advantage, but that is something we will talk about another day.)
Now that you owe the bank money, you don't have the privilege of free credit anymore.
The Rs 1,000 you spent is added to your outstanding balance of Rs 23,750. You are now expected to pay interest on Rs 24,750. As a result, your total interest now works out to Rs 730. This means you now owe the bank Rs 25,480 (Rs 730 + Rs 24,750).
So
The more you spend, the bigger the principal amount you have to repay.
The more you spend, the faster your debt mounts.
The month after, your credit card bill is Rs 25,480. You still don't have enough money, so you use the five percent pay back option and pay the bank Rs 1,274. You now owe the bank Rs 24,206 on which they will charge you interest .
And, until you clear your loan, every single payment you make using your card will be added to your loan amount and you will be charged interest on it.
This will go on till every single rupee has been repaid.
With barely any effort on your part, you have just entered a debt trap in which you end up spending more than you make and more than you can afford to pay.
Lesson to be learnt: Use your card only as a convenience. If you use it to spend more than you can afford, all you do is end up losing a lot of money.
Monday, November 22: How do you get out of this debt trap?