Credit cards can be a useful tool when used correctly and judiciously; but for first time users it can also be a bit confusing. In this post, we want to break down the ABCs of credit cards that one must know including few important concepts that are applicable - minimum amount due, interest charges. Have you wondered that if you buy something today with your credit card, and have to pay for it after 30 or 50 days, what exactly is in it for the credit card companies? Worry not, we will also try and understand how credit card companies make money so you know the habits to avoid. Let's dive in!
What is a credit card?
A credit card is essentially a loan. This is offered to the user by the issuer and allows the user to borrow the money (to make purchases) for a specific period of time. Debit Cards on the other hand, use the money which is available in your bank accounts, Credit Cards allow you to borrow money from the issuer and pay it back in full or in installments over a time period.
If you look at your credit card statement, it will show a few terms.
Total balance - the total amount which is due to be paid for the specified time period - usually the previous month's billing cycle.
Minimum Amount due - this is the minimum amount of the Total Balance that you need to pay before the due date. Let us understand this in detail.
How does "Minimum amount due" work?
The Minimum amount due is the minimum payment that you must do on or before the due date to avoid penalties like late fees and be in the good books of the Credit card issuer. However, paying it is important to know that paying only the minimum amount means the balance amount is carried over to the next month and you will be charged interest on this amount.
For example, if your total bill is ₹10,000 and the minimum
amount due is ₹500, paying just ₹500 means you still owe ₹9,500, which will
start accruing interest from the next month. Over time, this can lead to more debt
and higher interest charges.
Tip: While paying the minimum is ok, it’s best to clear the complete balance on time to avoid accumulating
interest on your balance.
How does Interest work for Credit Cards?
This is a complicated topic and credit card companies have elaborate strategies so that they earn high interests at the same time retain "favorable customers". Favorable customers are not necessarily customers who pay the full dues on time every time (else they would not earn a single Rupee in interests, late fees, etc). We will do a complete separate post on this. For a basic insight on how interest works, simply put - when you don't pay your bills in full, the balance amount incurs and interest charge. Credit Card companies usually levy very high interest charges - in the tune of 3-5% per month (which convert to 36-60% on an annual basis!!!), which can add up quickly if you are not careful and keep carrying forward balance dues every month.
From our previous example, for the balance ₹9,500 which was carrier forward, with the interest rate of 3%, you'll be charged ₹285 as interest the next month, and
your balance will now be ₹9,785. This cycle continues until you pay off the
full amount.
How do Credit Card Companies earn money?
Interest on Unpaid Balance: Credit card companies earn money primarily through interest charges on unpaid amounts which we saw earlier.
Fees: Other income sources for credit card companies are fees, such as late fees, annual fees, and over-limit fees.
Merchant Fees: Every time you swipe your card, the merchant pays a small amount to the credit card company.
Credit card companies make money when customers make only the minimum payments, miss payments, or exceed their credit limits and merchant fees.
Conclusion
Credit cards come handy, help you build a credit history and manage your finances, but you must use this tool responsibly and keep track. Remember - pay on time and preferably in full, avoid being late, and avoid carrying a balance.
Hope this was useful! Swipe responsibly!
We have also written a more detailed post on the interest charges of credit cards.
Comments
Post a Comment