When swayed away by a number of surrounding myths, we fail to understand the financial mechanics and end up paying more.
We can use the credit cards wisely if these myths are debunked and the basics of the product are well understood.
Let us now proceed to unravel the mysteries and debunk the myths.
Understanding interest calculation
Calculating the interest is the most challenging task because of the following reasons:
The interest is calculated on a daily basis but charged on a monthly basis.
Customer spending changes from day to day, and thus the principal amount is not same throughout the month.
The Grace period allowed adds a twist to it.
Let us get familiar with the following key concepts.
Billing cycle: It is the period within which all purchases and repayments are accounted and billed. Normally it consists of 30 days.
Grace period: This is an additional period of 15 or25 days added to the total number of days in a billing cycle.
The payment of the full outstanding amount before the grace period incurs no finance charges, provided that the previous month’s balance is paid in full.
Minimum balance or amount: It is the minimum amount that a customer pays to avoid the penalty charges for not paying the total outstanding amount for a billing cycle on the payment due date.
It is usually around 5 per cent of the total balance.
Average daily balance method: ADBM is a common method employed to tackle fluctuating balances by charging interest on the average of the daily balances throughout the month.
The weighted average method is used rather than the straight average method.
The straight average method uses the monthly average balance, but the weighted average method assigns different ‘weights’ to different balances that changes over a month.
Here, the weights used are the number of days assigned to each balance.
The myth of minimum balance: Many people assume to have offloaded their debt burden on the payment of minimum balance, but always bear in mind that the unpaid balance remains intact and the interest is compounded.
Apart from this, the concept of grace period comes to a halt and your credit score takes a beating.
The agenda of the banks is to keep spending without paying the penalty charges, and thereby increase the total debt owed to them.
Tip 1: Never take the bait, knock off your balance before the grace period.
The myth of uniform interest rates: Many customers have a notion that uniform interest charges are applied to different kinds of borrowing, but cash withdrawals attract very high interest rates that are exorbitant by any standards.
Tip2: Never opt for cash withdrawals.
The myth of grace period: Grace period applies only if there is no carryover from the previous month, and the current balance is paid in full within the grace period.
This interest free period ceases to exist even if one rupee is carried forward from the previous month.
The customers who use the grace period wisely and pay no interest at all are branded as convenience users.
They aren't only availing interest free short term loan butalso end up with good credit scores and reward points.
Tip3: Become a convenience user.
The myth of credit score: The myth that credit scores are based only on spending is baseless.
All credit scores are based not only on the frequency and the amount of spending but also mainly on prompt repayments.
Tip4: Anchor your score points on prompt repayments.
Announce of prevention is worth a pound of cure: Now, let us look at a few preventive measures to ensure that things don’t get out of control.
There isn’t anything called free lunch, but when used wisely, your credit card becomes one.