Do you pay only the minimum amount due on your credit card bill? Can this lead you to a vicious cycle of debt trap? Paying the minimum balance against a credit card is an unintelligent financial decision. Why is it so?
Why should you pay an 18 per cent interest when personal loans are available at 13 per cent and gold loans at 14 per cent? Or take a loan against your provident fund at 12 per cent or partially withdraw you public provident account to pay off your credit card’s outstanding balance? Is it not foolhardy to pay 18 per cent to credit card companies by opting for minimum balance payment?
Credit card companies are happy with customers who go for the minimum balance option. This is because these companies charge an interest of 18 per cent per year, or sometimes even more. But how does this work?
Credit card companies do not make much money from customers who pay 100 per cent balance whenever it is due. Therefore, they 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 = debt trap
Why do you agree to opt for minimum balance payment? In India, credit card companies (mostly banks or financial institutions) usually offer credit card customers two options for repayment: 1) pay minimum balance of 5 per cent, and 2) pay 100 per cent of the outstanding balance. People often opt for paying minimum balance on credit cards’ as they find paying a much smaller amount every month quite attractive. This is the debt trap credit card companies lay, and customers foolishly fall for it. You forget how expensive this facility of paying the minimum balance really is.
Let us see how expensive it actually is by taking an example. Madhuri has a credit card with a balance of Rs. 50,000 with 18 per cent interest rate, and the minimum payment she has to make each month is Rs. 2,500. It would take her over 5 years to pay the entire balance of Rs. 50,000. By the time she makes her last payment, she would have paid Rs. 75, 000.
To understand how it works against her interest, let’s say she purchases a sauna bath suite for Rs. 50,000. Once she finishes paying via minimum payment option, she would have paid 50 per cent more for the same product she purchased. Meanwhile, the value of her sauna bath will keep dropping with each passing year towards her last payment.
Will she own that sauna bath 5 years from now? Why does it work out to be so expensive? It is simply because 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.
Pay minimum balance and you’ll miss 21 days’ grace period
There is another disadvantage that comes along with the minimum balance option. Usually, the billing cycle of most credit card companies is one month plus 21 days of grace period. If you have opted for the 100 per cent balance payment, you will get the benefit of 51 days to make your 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 who go for 5 per cent minimum balance payment option?
In the first billing cycle, you will get the benefit of 30 + 21 = 51 days if you have used your credit card on the first day of its billing cycle. Once you have taken the option of paying the minimum balance – 5 per cent of the outstanding amount – the remaining 95 per cent 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 make the payment. This is called double jeopardy.
The best option
The best option is to pay the 100 per cent outstanding balance. In case you need to opt for a low payment, try to pay as much amount as possible by taking recourse to raising funds by other means to reduce the outstanding balance amount and thereby the interest burden. Avoid being victim of the trick of credit card companies.
- Dealing With Credit Card Debt: How to Get Debt-Free (fool.com)
- Getting Rid of High Interest Credit Cards (creditrepair.com)
- 4 secrets credit card companies don’t want you to know (rappler.com)