Common credit card pitfalls you should avoid --- Abitha Deepak

http://www.dnaindia.com/money/comment-common-credit-card-pitfalls-you-should-avoid-1462385

Friday, 5 November 2010

The usage of credit cards in India has changed, compared to yesteryears. 
In recent times, credit card usage has seen a significant decline compared to the rapid growth enjoyed earlier, especially between 2005-2008.

After that, due to the global financial crisis, credit card usage took a dip, replaced by a consistent rise in the usage of debit cards.

Credit cards can be a smart tool if made use of the right way, especially when you want to ramp-up a good credit score. Here are some common pitfalls you need to be clear about, in order to make optimum use of your card:

Understand the due date and ‘interest free’ period
The ‘interest free’ period should not be taken for granted. To understand this, let’s take the example of Ashish. His credit card provided him interest free credit for up to 55 days.

But Ashish learnt the hard way that he does not get a 55-day interest free period for every purchase he makes! A 55-day interest free period only means that the maximum number of days you won’t be charged interest for a new purchase is 55 days, and this is tied to the day of the payment cycle and the day you make your purchase.

Ashish’s credit card statement starts on the first of every month and ends on the 30th or 31st of every month. His due date is the 25th of the next month. 
This means that there is a total of 55 days from the first day of each month, when his bill is due, that he won’t be charged interest.

Now let’s say he made a purchase of `100 on October 1. No interest will be charged on the amount of the purchase up to, and including, November 24. So, he will get 55 days interest free on the purchase billed to his credit card on October 1. But if Ashish makes a purchase on October 20, he has only a 35-day interest free period. And if he makes a purchase on October 31, he will not get charged interest for 25 days (until November 25, when the bill becomes due).

Never make withdrawals! 
While Ashish did get confused with the interest free period, he had the good sense to know that an interest free period did not hold true in the case of cash withdrawals. In credit cards, the interest rate meter starts ticking the moment cash is withdrawn from the card, not to mention an additional withdrawal fee of around 3-4% is also charged.

Minimum payment and what it implies 
Your credit card company will normally require around 5-20% of the total amount due as ‘minimum payment’, to be paid up before the due date specified in your credit card statement.

If you do not pay even the minimum amount, then late charges will also be added, along with the interest on the outstandings.

If you opt to pay the minimum amount due, the unpaid amount is carried forward to the next billing cycle and so on, under revolving credit facility. Note that if you are revolving your credit, fresh purchases will not enjoy an interest free period i.e. you start paying interest from the day on which you make a purchase.

This will continue till the total amount due has been paid. Also, even if you pay the minimum amount due, interest will be charged on the total amount due. 
Consider the example of Deepti Thakur, who used her credit card extensively, usually for more than 80% of her credit limit of Rs1.5 lakh.

She had the habit of paying up only the minimum amount due before the due date. Let’s take an instance where her expenses on the card amounted to `1 lakh, and see how much interest she had to eventually shell out by the time she repaid the amount due in full, by paying only the minimum amount due (5% of outstanding).

At the 38% interest that credit card companies charge, Deepti paid a whopping Rs1.62 lakh as interest! Add the Rs1 lakh of principal, and Deepti’s total outgo was Rs2.62 lakh — all to clear dues of Rs1 lakh, using the revolving credit facility.

Remember, this is calculated without taking into account her future expenses on the card, assuming she does not use it after this particular billing cycle.

Credit card and credit limit — its impact on credit score 
One of most effective ways of utilising your credit card is to plan your spending and repayment in a manner that boosts your credit score. Never exceeding 40% of your credit limit has a very beneficial effect on your credit score. It shows that your credit limit is high, but you have not burnt it up and have plenty in reserve. This logic helps you attain a much higher credit score. Remember, bad usage of your credit card can plummet your credit score. Your chances of getting a loan in future will become slim, or will come with a higher interest rate attached to it.

The writer is head, content & research at BankBazaar.com, an online marketplace for personal loans, home loans and car loans