They say “Necessity is the mother of all inventions”. Credit Cards were born out of the need to provide an alternative to cash. Almost half a century back, when credit cards were introduced, they became an instant hit. Till date, people love to use their “plastic money” for they are universally accepted, quick, easy and relatively safe, help you keep a record of your purchases through monthly statements, great for bill payments and provide a host of other benefits through their loyalty points programs.
Let’s step in to the wonderful world of credit and learn on how to use credit cards to our advantage by using them responsibly.
Different Types of Credit Cards
A lot of banks in India, offer credit cards such as Citibank, ICICI Bank, SBI etc. American Express and Diners Club, which are charge card companies also provide users with credit card services. They offer a
- Standard credit card – issued to individuals for personal use,
- Premium credit card – issued to individuals with high net worth and those expected to carry high balances on their cards,
- Secured credit card – issued against a deposit with the bank to those individuals who have a low credit score and
- Corporate credit card – used by businesses to cover their day to day business expenses in a convenient way.
Though the credit card market is highly competitive yet companies have a variety of offers and terms attached to their products. For example, some companies tie up with one or more airlines and service flyer miles in return for purchases made, some offer free fuel while others will have discounts on dinning out, online shopping or even cash back. Apply for credit card today, if you haven’t already.
The Interest Free Period on a Credit Card
As the name suggests, credit cards are plastic cards that are meant to provide you with money on credit for a short period of time. If the charges made are not repaid in full on or before the due date, then the credit company will levy a hefty interest rate on your outstanding balance. For example Citibank credit card rates are roughly 37% to 42% annualised, ICICI bank’s 40.8% while SBI Gold card charges 40.2%. At this rate, credit cards become the costliest forms of unsecured personal loan available in the market. This interest is levied only upon outstanding balance on your card. That is the balance that you roll over to the next billing cycle after your payment due date has passed. Once the card has been fully paid, the credit limit is restored. That is why it is alternatively called as a ‘revolving line of credit’.
However, if you are able to make the payment in full every month, you can enjoy an interest free period of 45 to 55 days every cycle. No kidding!! A billing cycle is usually for 30 days and the payment due date is almost 15 to 25 days after that. The gap between your billing cycle and due date is also known as the grace period. Your balance does not attract interest up until after the due date. Let us elaborate with an example:
Mr. Aggarwal holds a credit card of New Bank. His billing cycle begins on 1st of every month. He has a credit limit of Rs. 1, 00, 000/- with a cash withdrawal limit of Rs. 20, 000/-
Jan 1st: Billing cycle begins
Jan 3rd: Car serviced – 10, 000
Jan 4th: Electricity Bill Paid – 3, 500
Jan 6th: Purchased Online – 5, 000
Jan 10th: Groceries – 5, 000
Jan 15th: Fuel refill – 3, 000
Jan 18th: Dinner at Restaurant – 1, 500
Jan 25th: Mobile phone bill – 1, 200
Jan 25th: Annual Insurance Premium – 10, 800
Jan 30th: Billing Cycle Ends
Total Billed Amount: Rs. 40, 000/-
Available Credit Limit: Rs. 60, 000/-
Available Cash Limit: Rs. 20, 000/-
Due Date: Feb 15th
Situation 1: Mr. Aggarwal makes the entire payment of Rs. 40, 000/- on Feb 15th and does not carry any outstanding balance onto the next billing cycle. He is not charged with any interest and his entire limit is restored to 1, 00, 000/- provided he did not make any charges after Jan 30th.
Situation 2: Mr. Aggrawal makes part payment of Rs. 15, 000/- on Feb 15th. He rolls over Rs. 25, 000/- to the next cycle. This outstanding balance of Rs. 25, 000/- will call for an interest charge.
Situation 3: Mr. Aggarwal does not make a payment at all. His entire balance of Rs. 40, 000/- is charged an interest and late fees is applied.
So you see, from Jan 1st to Feb 15th, until Mr. Aggarwal made the payment to his credit card company, he had the funds lying in his savings account earning interest, while making the full repayment attracted no interest charge. This way he was able to enjoy credit for 45 days without paying any interest on it.
This way he made money on his funds and didn’t spend an extra dime to use credit. This behaviour if adopted constantly will help improve cibil score over time and is viewed by lenders as a responsible financial attitude.
The Shortcomings of Using a Credit Card
Often one is unable to curb the temptation to frequently charge the card or easily loses sight of the quantum of expenses made when using a credit card. The stark reality does not surface until the monthly statement comes knocking on your door. It is thus very important to keep a track of your unbilled statement and make sure you can bear the expenses which you put on your card.
More often than not, people fall for the “zero annual charge” scheme. Low credit card fees are usually kept as introductory offers to expand customer base. Therefore, before you finalise any credit card make sure you understand its terms, the rate of interest, your billing cycle and rewards points that you will earn.
If you make the payment before the due date, then you are not utilising the credit period to its maximum capacity. If you make the full payment using a cheque on the due date then possibilities are that your payment will be considered late depending on when it clears.
If you fail to make the payment on the due then you not only draw a late fee but also an interest charge on your outstanding balance. This can have brutal impacts on your credit score.
Read our blog to learn about ways to improve credit score fast.
The Bottom Line
Credit cards are certainly highly alluring for they leverage your purchasing power and you can make payments without batting an eyelid. Vis-a-vis, when one uses a debit card, the money is immediately deducted from the account. Unfortunately, they can be detrimental to your financial health if not used responsibly.
Do note that the interest free period is upto 45 days to 55 days when you count the days from the beginning of the billing cycle. It is not 45 days to 55 days for each and every payment. So for payments made towards the end of the cycle, the interest free period will be not more than 15 – 20 days. If used wisely, you can save a ton of cash through discount offers, introductory coupons, cash back offers etc, save on interest on money in savings account and build on a strong credit record with credit cards.
Author: This article is contributed by Arun Ramamurthy, Director – CreditSudhaar