When credit cards become debt traps

Shachi Bansal, a 24 year old banker thinks of herself as a responsible person, because she pays off her bills on time. Surely enough all her utility bills are paid well before their due date, but what she remains confused about is that even though she is paying the minimum payment due on her credit card her balance does not seem to decrease.

Little does Shachi realise, that she is fast falling into a debt trap!

Most people do not understand how minimum payments are calculated on credit cards and thus end up paying much more interest than they should to the card issuers.

Here's what you need to know about how the minimum payment due on your card is calculated and how it can wreak havoc on your finances if you are not careful.

How do lenders calculate minimum balance?

Credit card companies have different standards for calculating the minimum amount due, but largely the industry standard remains 5 per cent of the total account balance plus interest.

You opt for the minimum amount because it seems like a lesser burden each month, but what you do not realise is that you are making a far bigger interest payment to your issuer.

Let's understand with an example.

Baishakhi has an outstanding of Rs 50,000 on her credit card.

Since she has opted to make the minimum payment of Rs 2,500 per month and her card company is charging an annualised interest 36 per cent on it!

This means it will take her 31 months to pay off her entire dues.

And by the time she will have made the last payment, she will have paid the card issuer Rs 77,500.

You automatically miss your grace period

A grace period is the number of days you have in hand to pay your dues after your monthly billing (21 days usually). So effectively you have 30 days (your billing cycle) +21 days of grace period meaning a total of 51 days to pay off your bill.

But this will only work in your favour if you are paying off your total outstanding.

If you are opting for the minimum 5 per cent payment, the 95 per cent remaining will be automatically rolled over to the next billing cycle, and you will not have the option of a grace period at all.

Lastly, getting into a minimum payment due cycle will affect your CIBIL score negatively as you will perpetually have a high utilisation on your credit card. A bad CIBIL score may hamper your chances of getting a future loan.

Thus, the wise thing to do is clear off all your outstanding dues on your credit card all at once. If you do not have the money to do it ask for a loan from family or friends, skimp on your expenses or even take a personal loan to get over this financial jeopardy!

If you keep ignoring this crucial aspect of your finances you may find yourself falling into a pit of debt that is endless.

The author is Co-founder and Director Credit Vidya.