Credit Card Minimum Payment Does Not Help

The plastic money is fast replacing the paper currency of the yesteryears. But the rules that govern this new type of money pose a lot of confusion and if you are a newbie in business, then the calculations could be mind boggling! Unless you are in complete control of your finances, you could end up in debt mire before you realise it. While spending is an integral part of everyday living, ensure that it is done after thoughtful planning. Credit card companies lure you with minimum payments for your purchases but if you analyse it you will find yourself paying a lot more than you actually spent. To find out about why minimum payment against your credit card will not help you in the long run, read on.

Every credit card company sets a minimum amount to be paid each month against the credit outstanding in your name. For example, if you have an outstanding bill of Rs.10000, you may be required to pay a minimum of Rs.1500. The minimum amount set by different companies is different. You must be aware of the limit set by the company that has issued you the credit card. Technically the companies have to set a minimum limit in such a way that part of the principal is repaid every month and even this differs from company to company. For the outstanding amount the company charges an interest ranging between 30-38% in India. It is important to know the interest that the company charges on the balance amount due.

While it is sufficient to pay the minimum amount each month, it is important to understand the implications of paying the minimum amount and keeping the rest as outstanding. Assume a situation where you take a housing loan. The interest charged is generally between 9-12% in India. Paying this interest amount is unavoidable as it is impossible to have ready cash against which you can buy a house at any given point. But consider the scenario in which for the provision, clothing, eating at a restaurant, etc. you spend through credit card and end paying 36% interest on the outstanding amount. Though it may initially seem a small amount say Rs.20000, which you spent in buying some consumer durables, you may end up with a huge debt and spend years paying it off. The durables that you buy may wear off much faster than the loan amount. If you are smart enough to budget your expenses and spend wisely using your credit card, you may keep unpaid portions and maximise the returns on your money and pay off the balance using the profit. But if such calculations are not your cup of tea, it is better to keep a strict watch on your spending habits and buy only what you can pay for.

In the event of a huge outstanding you are bound to panic. This can happen to people who are not in the habit of prioritising expenses and spending wisely. In such a case, it is not impossible to climb out of such huge debts. The first thing that you have to do is to cut out on wasteful spending. Then with the extra cash you generate every month, pay off more than the minimum requirement each month. This will not only bring down the outstanding amount, but also the interest charged against the outstanding. You should try to spend carefully and avoid impulsive purchases. This will help you regain your financial balance and you will be able to enjoy your earnings to a greater extent.

Let us consider a situation where you have an outstanding bill amount of Rs.20000. If your credit card company has set a limit of Rs.1000 as minimum payment, at the end of the first month, you will be under the impression that you have an outstanding of Rs.19, 000. This is a myth. The company has added back an interest amount of Rs.316 (at about 20% p.a.) and this amount makes your outstanding as Rs.19316. The second month you pay Rs.1000 and the interest added back is Rs.305.

In this manner 20% of the amount outstanding gets added back into the outstanding for the next billing cycle. If the minimum payment is very less, the interest component increases till it becomes very difficult to pay off the outstanding amount. When you eventually wipe off the outstanding amount you could have ended up paying even 8-10 times the original amount you took as loan from the credit card company.

If you are hooked to making minimum payments every month then be aware as your credit worthiness is going to take a severe beating and may hamper your future loan prospects as credit rating agencies are watching all your details.

To summarise, there are a few facts that you must ask your credit card company before you buy the card from them. Find out, for example the minimum amount, the interest on the outstanding and the principal amount that gets wiped off every time you make a payment. Choose a card that has a higher minimum amount and lower interest rate. Once this is done, use the reward points to your advantage so that you do not pay for every purchase, but combine purchases to earn maximum reward points. Manage your expenses within your earnings and keep your loan outstanding to the bare minimum. It is a good practise to use cash wherever possible and keep credit card purchase to only bulk purchases.

Remember money saved is money earned!