Primer. Why settle credit card dues on time

“Pay back your credit card dues first” — that’s what financial advisers invariably recommend to clients facing debt trouble.

This advice comes with good reason; the rates of interest on credit card dues are exorbitant and could ruin your finances. But this does not mean you do away with the credit card altogether.

It offers a great deal of ease and flexibility — cashless shopping, offers, reward points, and to top it all, a free credit period when you don’t have to pay for purchases. So, the amount remains in your bank account earning interest.

These benefits though ask for a small price in the form of payment discipline. Pay you must, in full and by the due date. Payment defaults and even part-payments can burn a big hole in your pocket.

At 2.5-3.5 per cent per month (sometimes more), the interest charged on credit card dues works out to a staggering 30-40 per cent a year. This makes credit card debt among the costliest in the market. Then, there are late payment charges on payment defaults and service tax to add to the woes.

Credit cards allow ‘revolving credit’ — this means that you can make a minimum payment (usually 5 per cent of the total sum due) by the due date and carry forward the balance to the next billing cycle. It sounds good, but hardly is. When you opt for the ‘minimum payment’, you kiss goodbye to the free credit period. So, on the bill amount, you get charged interest right from the transaction date, and not just from the due date. On new purchases after the bill date, the interest cost meter starts ticking right away.

Say, your credit card billing cycle is from September 1 to September 30. You spend ₹10,000 on September 10. The billing date is October 1, the payment is due on October 15 and the minimum payment due is ₹500. You also make purchases of ₹5,000 on October 17.

If you pay the entire September due of ₹10,000 by October 15, you get free credit period of up to 35 days (September 10 to October 15) and free credit on the purchase of ₹5,000 in October. But if you make only the minimum payment of ₹500 by October 15, you get charged interest from September 10, and lose the free credit period on the purchase made in October.

Say, you settle the balance dues of ₹14,500 (₹9,500 plus ₹5,000) on October 25. Interest cost will be calculated as follows: on ₹10,000 from September 10 to October 15, on ₹9,500 from October 15 to October 25 and on ₹5,000 from October 17 to October 25. At 3 per cent a month or 36 per cent per annum, the interest cost works out to more than ₹478. Add to this service tax at 14 per cent and you will be left poorer by about ₹545.

The minimum payment option can be useful if you face a temporary cash crunch. But make a habit of it and you could soon find yourself in a debt trap.

The payment will run into years, with massive interest outgo. For instance, if you spend ₹5,000 on the card and pay back only the minimum due each month, it could take you more than six years to clear the account. Your credit score will also take a knock. Ideally, pay in full, or at least as much as you can in excess of the minimum due.

A saving grace in paying the minimum due is that you do not get charged late payment fees. You escape the defaulter tag and could face a lesser negative impact on your CIBIL score.

Some credit card issuers also charge a higher rate when you do not pay even the minimum amount due.

You can use your credit card to withdraw cash from ATMs. But do this only when you are left with no other choice.

Cash advances on the card don’t enjoy free credit period and are charged interest at the usual high rates from the date of withdrawal until they are repaid.

Also, a transaction fee of 2.5 per cent to 3 per cent is levied on such withdrawals.

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