Do you pay only the minimum amount due on your credit card bill? Will this lead you to a vicious cycle of debt trap?
Paying the Minimum Balance in Credit Card is an unintelligent financial decision. Why it is so?
Why you should pay 18% interest when personal loan at 13% or gold loans are available at 14% or take a loan against your provident fund at 12% or partially withdraw you Public Provident account and pay off your Credit Card outstanding balance? Is it not foolhardy to pay 18% to Credit Card Companies by opting for Minimum Balance Payment?
Credit Card companies are happy with Credit Card customers who pay Minimum Balance
You will make Credit Card companies very happy by opting for paying minimum balance of your outstanding credit usage as the Credit Card companies charge interest rate at 18% per annum or more. But at whose cost?
Credit Card companies do not make much money from credit card customers who pay the entire 100% balance whenever it is due. Therefore, Credit Card companies prefer credit card customers who opt for paying minimum balance and pay interest on the remaining outstanding balances. This is the trick Credit Card companies play with their unsuspecting customers.
Paying Minimum Balance is falling into a Debt Trap
Why you agree to opt for minimum balance payment?
In India Credit Card companies (they are mostly banks or financial institutions) usually offer credit card customers two options for repayment, either to pay minimum balance of 5% or 100% of the outstanding usage balance. You opt for paying minimum balance in your credit card outstanding balance because you find it attractive as you will be paying a much smaller amount every month.
This is the Debt Trap Credit card companies lay for you and you foolishly fall for it. You forget how expensive is this facility of paying the minimum balance?
Let us see how expensive it is by taking the example of Madhuri who has a credit card with a balance of Rs50,000 with an 18% interest rate and the minimum payment was Rs. 2500 each month, it would take her over 5 years to pay the entire balance. By the time she makes the last payment, she will have paid Rs. 75,000.
To understand how it works against her interest, let’s say she has purchased a sauna bath suite for Rs. 50,000. Once she pays the credit card balance making only the minimum payments, she will have paid 50% more for that sauna bath suite while watching the value of her sauna bath suite drop with each passing year.
Will she own that sauna bath 5 years from now? Why does it work out to be so expensive? It’s because the credit card companies employ tricks to keep customers paying more. This is the way they make money by putting people like Madhuri in a Debt Trap.
Paying Minimum Balance will make you Miss the Grace Period of 21 days
You do not know that there is an additional disadvantage by paying the minimum balance. Usually the billing cycle of most Credit Card companies is one month plus 21 days of grace period to pay the outstanding balance.
If you have opted for 100% balance payment, in that case you will get the benefit of 51 days to make the payment in case you have used the credit card on the first day of the billing period. In case it was used on the last day of billing period you will get a grace period of only 21 days.
Now what happens to people like some of us, who opt for 5% minimum balance payment?
In the first billing cycle, you will get the benefit of 30 + 21 = 51 days if you have used the credit card on the first day of the billing cycle. Once you have taken the option of paying the minimum balance of 5% of the outstanding amount, the balance 95% will be rolled over and the interest will be charged for the next billing period of 30 days on this amount and you will not have the option of the grace period of 21 days to pay the amount. This is called double jeopardy.
What is the best option?
The best option is to pay the 100% outstanding balance. In case you have to opt for minimum balance payment, please try to pay as much amount possible by taking recourse to raising funds by other means (some example have been in the opening paragraph) to reduce the outstanding balance amount and thereby the interest burden. Avoid being victim of the trick of credit card companies.
The author is Ramalingam.K an MBA (Finance) and certified financial planner. He is the Director & Chief Financial Planner of holistic investment planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He Can be reached at firstname.lastname@example.org