5 MinsAug 31, 2022
Siddhi Bhaskar, 24, got a job with a digital firm soon after she completed her post-graduate diploma in marketing and advertising from a reputed institute.
Six months later, she applied for her first credit card, which the bank was happy to grant, considering her steady income of about Rs. 40,000 per month. Delighted with her newfound ability to pay without having to shell out cash up front, Siddhi
She bought herself some new clothes, a lovely bag she had been eyeing for a while besides splurging on cosmetics and new sunglasses. Her first month’s bill was about Rs. 30,000 with a Minimum Amount Due (MAD) of
Rs. 2,000. She paid it promptly on the due date.
This pattern of spending and paying the MAD continued for a couple of more months till, in the fourth month, she was confronted with a total bill of over Rs. 80,000. Siddhi got alarmed
and spoke to her Axis Bank Relationship Manager (RM) about how to get out of the situation. The RM explained the pitfalls of paying only the MAD.
1. High Interest Rate:
If you look beyond the convenience, credit cards are a form of an unsecured loan being offered by the issuing bank. Because the loan is not backed by any mortgage, it carries a very high rate of interest
– typically between 3-4% per month, translating to 36-48% per annum.
MAD is typically about 5% of the outstanding balance. If the customer pays only the MAD by the due date, the bank charges this interest on the outstanding amount.
This can be financially ruinous. The RM gave a simple example. Assume, she told Siddhi, that the total outstanding after paying MAD was Rs. 10,000, and the applicable interest rate was 3% per month. Also, assume that Siddhi doesn’t
spend any money on her card further.
|Outstanding Month 2||10000|
|Interest on outstanding amount||300|
|MAD Month 2||309|
|Outstanding Month 3||9991|
|Interest on outstanding amount||300|
|Outstanding Month 3||10291|
|MAD Month 4||515|
|Outstanding Month 4||9776|
In this calculation, despite paying Rs. 809 (Rs. 309 for Month 2 + Rs. 515 in Month 3), Siddhi’s total outstanding has only been reduced by Rs. 224. The rest of the payment has gone towards servicing the interest.
2. Interest-Free Period:
The situation could worsen if Siddhi continued to shop while still paying only the MAD. This, the RM explained, was because of the peculiar nature of credit card debt.
When a customer uses a
credit card to make payments, the bank offers a period, typically about a month, when no interest is charged. However, if the customer doesn’t clear the entire outstanding amount before the due date, the bank would charge interest, not
just on this amount but on any subsequent spending till the whole amount is cleared. So, if Siddhi has an outstanding amount of Rs. 10,000 and spends another Rs. 10,000 next month, the bank will charge its interest on Rs. 20,000 and not just
on the new spend of Rs. 10,000 in the month. Such a pattern of spending and only paying the MAD could land her in a debt trap.
[Also Read: Enjoy easy and convenient transactions with credit cards]
3. Impact on Credit Score:
Credit scores are essential when a customer applies for any loan. If someone only pays the minimum amount on a credit card every month, credit bureaus tend to regard this as a sign of someone who
is not a very good credit risk.
A bad or not-so-good credit score can impact Siddhi’s ability to get loans. Either the banks will reject her loan application, or if they approve, they will most likely make the loan terms stiffer.
What Should Siddhi do?
The RM told Siddhi that she should check with her card-issuing bank if she could convert the total outstanding on her card into EMIs (Equated Monthly Installment). Such EMIs come at a much lower interest
rate, saving Siddhi money.
For a few months, while she is paying off the existing debt, Siddhi should curtail her expenditure. Also, as far as possible, she should always pay her credit card bill in full before the due date.
Axis Bank offers a range of credit cards with various benefits tailored to its customers' preferences. Customers are also entitled to Edge Reward points depending on their spending patterns. You can redeem them for a range of attractive deals and offers.
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