CREDIT CARD - A HELP OR A TRAP ?

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INTRODUCTION 


We often hear about credit cards. Some of us believe that credit cards are really good as they help us to buy even those goods which are quite costly and we can't afford to pay its price in cash at present. However many people think that credit cards are like a trap where they will get trapped by high interest charges.


By the end of this article it will be very clear to you whether the credit cards are a trap or a help for you.


How does it work ? 

Whenever you will approach a bank or any financial institution which is issuing credit cards, they will tell you the limit up-to which you can buy goods and pay for services and also the interest rate which they will be charging from you for the amount which you owe to them provided if you don’t pay the monthly bill of your credit card.


If you are able to pay your monthly bill or credit card then you don’t have to pay any interest on it. But if you aren’t able to pay your bill then interest will be charged on a daily basis.


Moreover the interest is charged on compounding basis in most of the cases, which means the interest will be charged on the due amount plus any previous due interest payment.

Now this thing is a warning signal and this makes it necessary to know how much will be charged from you.


APR


APR is the annual percent rate. The credit card issuing institution will tell you the annual interest rate which they will charge on the due amount. Moreover they will also tell you the daily periodic rate.

As i said earlier that interest will be charged on a daily basis so calculating the interest rate by using simply the APR will not give you the actual interest which you will pay. So you have to calculate the “effective APR”.


CALCULATION OF EFFECTIVE APR


For eg. your bank issued you a credit card where the APR is 25 % and the daily periodic rate is 0.067%. Now you made payments via your newly issued credit card and did a lot of shopping worth ₹70,000 and out of which you only paid ₹50,000. 


Now we will calculate the effective APR assuming that you didn’t pay the due amount of ₹20,000 for 365 days i.e. 1 year.


Amount you have to pay after a year = 20,000*(1+0.000676)^365

= 20,000*1.2797

= 25,595

 Which means interest paid by you is (25,595 - 20000) = ₹5,595, whereas if you will calculate interest by merely APR told by your bank i.e. 25% then interest is only ₹5000 which is less than what you have actually paid.


Therefore effective APR will be,

= (1+per day charge)^365 - 1

= (1+0.000676)^365 - 1

= 1.2797-1

=0.2797

= 27.97 %


So you are actually paying around 28% p.a. interest not 25% p.a. .




WHEN TO BUY USING CREDIT CARD


You should make payments via credit cards when you are assured that you have a recurring and stable source of income. Moreover don’t keep the credit card idle, make payments using a credit card because you also have to pay an annual subscription charge on the credit card. So it is a fixed cost for you, so if your financial position is not good and you are not assured of a stable source of income don’t buy too much using a credit card, just make payment of petty expenses through it.


Never make use of a credit card for making payment of business expenses as it can be very risky because income from business is not stable , you may suffer loss also. 


BOTTOM LINE


Follow these 2 “mantras” so that your credit card can be a help for you and not a trap.

  1. Pay your credit cards bills timely 

  2. Use a credit card for big purchases only when you have a stable source of income in future, else pay only petty expenses through it.


If you do not follow these rules, you may end up paying high interest charges.



Shaurya Gupta

Bcom(hons), University of Delhi



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