Why not to revolve on your credit card

The festive season has begun and most of us are planning to splurge. Even when we don't have enough cash to pay for our purchases. Why worry when plastic can do it for you? Aren't credit cards made for such situations, you think.

Credit cards not only let you buy things on credit -- you have 52 days of free credit if you use them smartly -- but also allow you to pay a bare minimum -- 5 percent -- of your outstanding due. This is what lures most credit card users into a debt trap which many find difficult to get out of.

In difficult times when you are short of means to pay for your credit card bills, paying minimum gives you a breather. However, it may not save you from finding a concrete solution for paying your credit card debt. Soon you may find yourself reeling under a debt trap. Assuming that paying minimum of your outstanding amount is a good option is like digging your own grave.

If you are not aware of this or are confused by credit card jargon, don't worry. You are not alone. Revolving and minimum payment are the key terms to be learnt. Let's have a better understanding of the same.

Revolving credit and minimum payment

Revolving credit means once you get a credit limit you can use it -- that is, buy goods or services using your credit card -- as long as you stay within the given credit limit. It is required that each month you pay the minimum amount which also includes the interest charges. As your balance gets reduced, your credit limit increases by that amount and is available for use again.

• Credit card statement made easy 

For instance, if your credit limit is Rs 15,000 and you have made a purchase worth Rs 10,000, you'll have Rs 5,000 for future purchases. Now if you make a minimum payment which is normally 5 percent, that is Rs 500 in this case, you'll have Rs 9,500 available credit limit.

However, if you go on paying minimum then it will take years for you to cover your due amount. This is because it contains a large portion of interest component and a tiny portion of the balance amount. To avoid falling into this kind of a trap always make your total payment before the due date. This will help you save the amount you are paying as interest on your outstanding dues.

While you may feel happy about paying the minimum amount due on your account your bank will be happier! Why? Let us understand this with the help of the table given below:

• Are you revolving on your credit card?

Assume a scenario, where customer X has made purchases worth Rs 1,00,000 during the festive season. His minimum amount due on these purchases is 5 percent, that is Rs 5,000, and he revolves the balance (Rs 95,000) at an interest rate of 3.1 percent monthly (or, have a heart, 41.79 percent per annum including service tax).

As the table below shows in the very first month you pay Rs 5,000 on your total dues of Rs 1,00,000 leading you to believe that your total outstanding for the next month is just Rs 95,000. But, dear friend, there is interest to be paid to the company who has financed your purchases in the first place because there are no free lunches. So for the next month your total outstanding due will be Rs 98,483 (95,000 + interest and service tax of Rs 3,483).

This story -- if you let it continue by paying just the minimum amount due -- at the end of 12th month, will make you hold your head in disbelief. Why? Because in spite of paying Rs 55,238 at the end of 12 months you will still have an outstanding to pay of Rs 83,242 (see the table below). This is exactly the reason why your credit card company / bank will be happier if you keep paying the bare minimum due on your account or keep revolving your credit.

Moral of the story

~ If you pay minimum for the entire year, you may end up paying 5 percent more than the amount due.
~ Even after paying 50 percent of the due amount 83.24 percent of amount is still due. Rs 83,242 on an outstanding of Rs 1,00,000 equals 83.24 percent.
~ Even after paying 50 percent of the due amount you end paying only 16.75 percent of your outstanding.
~ It would take 196 months or 16 years if you further calculate how many months it would take for you to pay the entire outstanding of Rs 1,00,000. Yes it would take you 16 years to clear an outstanding of Rs 1,00,000! That is, you would pay Rs 3,13,148 for your credit card purchases worth Rs 1,00,000.

So you understand now what a big trouble you are inviting by opting to pay minimum on your credit card outstandings. In the short term, it will look like the most viable solution but in the long run it will have a serious impact on your finances. So avoid paying minimum and try to clear your credit card dues even before the due date.

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