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One has seen the latest smart phone or a laptop and the desire is to purchase it right now. Paucity of funds is a problem and one does not know what to do. Buy now spend later is the need of the hour. Credit is the name of the game. It is at this time that one remembers plastic money. A rectangular plastic card with a magnetic strip at the back and the name of the owner printed on the card famously called a credit card. With this card in ones hands all one's wants can be fulfilled. Time to shop?

What is a credit card?

A credit card enables one to borrow money from the issuer of the card mainly a bank .One pays for a product or a service using the banks money and has to repay these amounts over a period of time .Since the bank pays the amount one does not have to pay right away and can purchase an item even if he has no immediate cash. One has to pay for the use of the banks money which is basically someone else's money by repaying the amount with interest after a period of time just as in a loan. The bank sets a credit limit which is a maximum amount one can spend on the card. This could be 2-3 times ones monthly salary .It could also depend on the number of loans one is servicing which might impact the credit score. It mainly depends on the debt burden ratio which is the sum total of all EMI's being serviced divided by the monthly gross salary. One obtains a statement on a monthly basis which lists the number of transactions made as well as the amounts paid using the card .One can pay by submitting the credit card at the cashier and the account is validated by the merchant with the bank .If all conditions are satisfied with the bank such as one is within the credit limit then the transaction is processed and added to one's credit account. In order to accept credit cards the merchant has to pay a fee to the banks and the bank which issues the credit card collects these amounts as revenue.

What are the charges associated with a credit card?

A billing cycle normally consists of 30 days within which all purchases and repayments are accounted for and billed. An additional 25 days may be added to the billing cycle which constitutes the grace period. If one repays the total outstanding amount within this time period no interest is charged. If the amount is not repaid or a portion of it is not repaid within this time period it becomes an amount outstanding. One of the common tricks used by salesmen is to tell first time credit card users that they have 40-50 days to repay the amount on their credit card .All cards have a fixed due date by which all payments need to be made . If a purchase is made just 15 days before this due date ,the time left to make the repayment is the credit cards fixed due date and the credit card user has only 15 days to make his repayment.

• Late Payment Fee: Credit card issuers state a minimum amount which needs to be paid each month .The customer needs to pay a certain minimum amount in order to avoid a penalty for not paying the total outstanding amount on a billing cycle. This could be around 5% of the total outstanding balance. The least one can do is make these minimum payments which means the loan amounts would take many years to clear .If one is not able to pay even these minimum amounts then a late payment fee kicks in which could be as high as INR 400-700 for an outstanding amount of INR 5000-20000.
• Interest rate on revolving credit: One has to pay a very high interest rate if the credit card bill is not settled within the due date. Interest rates inclusive of service charges can be as high as 30-40% on the outstanding amount.
  Let us consider Mr Ramesh had an outstanding amount of INR 25000 after his due date which falls before 20th of each month. Mr Ramesh missed his due date of November 20th and paid his dues on December 17th.This was a late payment of 28 days. The monthly interest rate charged on the amount outstanding was 3.5% which is 42% on an annual basis.
  
  The interest rate is calculated using average daily balance method as follows:
  
  (Outstanding amount * 3.5% * 12 Months ) * Number of days / 365 Interest calculated= ( 25000* 0.035* 12) * 28 / 365.This means that an interest amount of INR 806 needs to be paid by Mr Ramesh as interest for the default.
• Service Charges: Banks also levy a service charge which could be around 12%.This is charged on the interest as well as the late payment fee. Mr Ramesh would be charged INR 700 as late payment fee along with the interest amount of INR 806 or ( 806+ 700) * 0.12 = INR 181. Now Mr Ramesh has to pay a service charge of INR 181.
  
  The total amount charged on an outstanding of INR 25000 in a single month is INR 181 +INR 806+INR 700 which translate to an amount of INR 1687.
• One can use a credit card to make withdrawals from an ATM. However a fee is charged for cash withdrawals with an interest rate which is higher than the standard rate of interest charged on the card. There is no grace free period on the interest payments, so on a cash withdrawal interest accrues immediately.
• Banks also charge certain other fees such as charges on the amounts which exceed limits, cash processing charges, fee handling charges for the redemption of reward points as well as foreign currency transaction charges .Many credit cards offer reward schemes such as a 10% cash back on movies, 20% off on the restaurant bill in order to stimulate customers to spend. However these schemes reward good customer credit behavior .If one indulges in late payments these benefits disappear.

What happens if one slides back on his payments?

The idea of using a credit card is all about the grace period. One would not be charged interest during this period. It is advocated that the least one can do is make the minimum payments on the credit card instead of the full amount. The problem with this approach is that the outstanding amount increases until it becomes a severe burden on oneself and his family. This pulls one in a debt trap. If one were to default on the repayments his credit score would be badly affected. Cibil a credit rating agency monitors one's credit card usage and assigns a score on a scale between 300-900.Too many cards or a consistent late payment might affect this score. One would find it very difficult to avail a car or a home loan if the credit score is poor .When one falls into a debt trap it is not easy to recover. The never ending cycle continues and one can find it very difficult to escape from this vicious circle .Balance transfer is an option which can be explored in order to escape from this cycle of debt.

What is a balance transfer?

In a balance transfer one gets a new credit card from another bank. The debts on one's existing credit card can be transferred to the new credit card. One can opt for a fixed duration or the lifetime duration balance transfer. The fixed duration offer is open only for a limited time period of about a year. All one's dues must be settled within this time period. A lower rate of interest is charged which might be around 8-9% per annum compared to the higher 30-40% per annum rate of interest charged at the standard rates. However one cannot miss a payment within this tenure as then interest would be charged at the standard rates. One also has the lifetime renewability option where the dues can be paid across one's lifetime. The interest rates are higher than the fixed duration balance transfer and are as high as 12-20%.A processing fee of around 2% of the outstanding amount is charged depending mainly on the bank. The bank in which the balance transfer in being exercised asks for the details of the old credit card which was issued by the previous bank. After the details have been verified by the new bank they will issue a cheque or a demand draft. This cheque or demand draft will be delivered directly to the customers address or to his bank.

What is the Equated Monthly Installments option?

One can opt for the conversion of the outstanding amount into equated monthly installments in order to repay the debt. Banks offer the EMI facility where the outstanding amount is paid off in parts. If one has to pay off an outstanding amount of INR 9000 then this amount can be divided into equated monthly installments .A banks existing customer can avail of this facility and benefit from lower interest rates of around 2% per month instead of 3-4% per month charged under standard conditions on one's credit card dues. This method can be used when one does not want to go through complicated documentation for a balance transfer.

Should one explore other loan alternatives?

In case one misses the due date on his credit card payments banks would charge interest rates as high as 30-40% per annum on the outstanding amounts. The idea is to replace costly debt with cheaper debt .One can take a personal loan ,a gold loan or even a loan against property and retire the debt on the credit card. These loans have a lower interest rate and suffice as a suitable alternative. A personal loan can be availed at an interest rate of around 14-22% which is cheaper than the interest rate charged on a credit card. One should always opt for a secured loan rather than an unsecured loan as interest rates are lower and secured loans have a positive impact on ones credit score .Banks charge as less as 13-15% for a loan secured against gold .A loan against property can have an interest rate as less as 12-16%.Ones bank would be very happy to sanction a personal loan or a secured loan. However a default on the personal loan can affect one's credit score.

Should one bargain with one's bank?

Negotiating with one's bank for a lower rate is certainly an option which should be considered. With serious competition between banks in this sector as well as the balance transfer option being available to the customer banks do compromise by lowering the interest rates .Banks would rather prefer charging a lower interest rate than a customer loan default which would add to its non performing assets.

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