Thursday, April 30, 2009

Credit Card – A Double Edged Sword!! - PART I

Went to the movie "Confessions of a Shopaholic" and enjoyed every bit of it. However, there were some serious issues underneeth all the laughter and the jazz. The fact that Credit Cards can be a very serious problem, if not handled carefully.

To have someone’s money with you, for 50 days and pay it back with no interest is a very tempting offer. This is the biggest utility of a credit card. They offer you money, interest free for a 45-50 day period. All you need to do is pay it back.

So how does bank makes money? Well the primary source of income for bank is the transaction fees that it earns every time someone swipes the card. So if I go and purchase goods worth Rs. 1000.00 from Globus (called merchant), I will be charged only 1000 bucks in my card. Globus in turn will pay my credit card issuer 2% as transaction fees. This 2% is shared by my credit card issuer, Globus’s bank and Visa/Master card. The underlying assumption for this fee is that I will not purchase anything if I don’t have a card. The other source of income for bank is the customers who don’t pay the whole amount due by the due date.

Let us understand the basics of the card before we get to the usage part.


Item 1: Statement Date: This is the date on which statement is generated every month.

Item 2: Payment Due Date: This is the date by which one needs to clear the total amount due if he/she does not want to pay any charges/fees to the bank.

Item 3: Credit Limit: A Credit Card is issued to an individual based on his income and his spending pattern. The bank has all these details as you operate your salary account in it. It will approach you through one of its agent and ask you to fill an application form. Once you have filled in the form with all the details, the application is processed by the credit department of the bank.

The Credit department, based on pre-requisites, decides on the credit limit of the card. So in the above case, credit limit is Rs. 1.19 Lakh. This is the maximum amount till which the cardholder can spend from the particular credit card during one credit cycle.

Item 4: Available Credit Limit: This is the maximum amount that CC holder can spend till he clears his outstanding amount. Once he clears his outstanding, the available credit limit will be equal to his actual credit limit.

Item 5: Cash Limit: This is the amount up to which he can withdraw cash from an ATM. This is a part of the credit limit itself and not an extra limit. So if he exhausts his available credit limit, he will not have any cash limit either.

Item 6: Transactions: These are the details of his transaction. It tells him when, which shop and how much did he spent. At times, the name of the shop may appear different than where you swipe your card. This happens when the shop’s name and the name used for banking purpose is different. The transaction details show the banking name of the merchant. It will have all the transactions from 09/07/08 to 08/08/08.

Item 7: Opening Balance: This amount was his previous month’s outstanding.

Item 8: Payments/Credits: This is the amount that he has paid during the period 09/07/08 to 08/08/08.

Item 9: Total Due: This is the total outstanding that he needs to clear on 28/08/08.

Item 10: Current Due: Also known as MINIMUM AMOUNT DUE, it is usually 5% of the total outstanding or Rs. 200, whichever is higher.

Smart Usage:

The best way to use the credit card is by the following way:

Try to make maximum purchase on the date after the statement date of the card. In the above case, on the 9th of every month. So if he swipes the card for Rs. 1 lakh on 09/08/08, the amount will be reflected in his credit card statement for the month of September, i.e. on 08/09/08. He gets a 30 Day Credit free period.

Now, make payment of the total outstanding of the statement (Rs. 1 Lakh) on the payment due date, i.e. 28/09/08 in above example. That way he gets another 20 day credit free period.

This way one can use 1 lakh rupees for 50 days without making any interest payment.

Will continue with the other side of the cards in the next section.