Many of us use one or more credit cards. It is a valuable piece of plastic, allowing the holder to essentially draw on funds unlinked to any existing deposit. In other words, it is an unsecured personal loan. Like any other loan, your credit card balance attracts interest, and that is where the matter really gets confusing.
This is because Credit Card companies have a record of couching their interest rate calculations in arcane financial jargon. Take a look at the documentation that came with your credit card when you first acquired it. Especially under the ‘Interest rates’ section, if there is one. Here you will find terms like Annual Percentage Rate (APR), Annual Interest Rate (AIR), Average Daily Balance (ADB), Daily compounded balance, and many more.
If that felt like something written in a foreign language, you wouldn’t be the only one who felt that way.
So how do we decode this puzzle? Well, the important number you should look for in the statement or documents of an Indian credit card company is the ‘AIR’. This tells you the Annual Interest rate on your credit card, and is comparable to the interest rate charged by Banks on other loans. So for example, if your Card’s promotional material says the interest rate is ‘only 2% interest’, it actually means 2% per month, which means your AIR is 24%. In fact, in India, the AIR for most Credit Cards is between 24 and 30%.
How is this interest calculated? Well, it varies, from company to company and card to card. Most charge simple interest on daily outstanding balance. This is calculated as follows:
Suppose your amount outstanding is Rs. 20,000/- and you pay it after 45 days from the due date. Interest will be:
20,000 x 20/100 x 45/365 = Rs. 493
Sometimes, a special scheme is run where you can convert purchases into EMI’s at a lower rate, but remember in such cases the lower rate is only applicable as long as you pay the complete due amount before the due date every month.
Now this ‘due date’ is another important aspect of Credit Cards. Your ‘amount outstanding’ is calculated taking into account the amounts you have spent in the course of the ‘billing period’. After the billing period is over (typically a one-month period, but not coinciding with the calendar), the credit-card company will give you a period (typically about 15 days) in which you can pay the entire outstanding amount without incurring any interest whatsoever. So in our example above, if this amount of Rs. 20,000 is incurred between the billing period of, say, June 21 to July 20, then the due date for paying it is July 5, and provided you pay the entire Rs. 20,000 in that time, you will not have to pay any additional interest over and above this.
Now if you pay nothing at all, you will incur ‘late fees’ in addition to interest. Most of us do pay something though – the credit card company helpfully tells you there is a minimum payable amount that you can pay, and we pay exactly that. The thing is, every time we do this, the rest of the amount – the amount not yet paid – adds to your outstanding amount, and the interest starts accumulating.
To illustrate this, consider our example above. Let us say that the minimum payable on that outstanding amount of Rs. 20,000 is Rs 1,500. If you pay only that much, the interest will begin to accumulate on the balance Rs. 18,500 from day one. And remember, the interest begins to be charged right from the day you made the expense, not the due date of the family.
In conclusion, let us summarize the main points that relate to Credit Card interest:
1. The relevant measure is AIR
2. It is annual interest as a percentage but charge on a per-day basis
3. If you pay the full due amount before the due date, no interest is applicable
4. Interest is applicable from the day of expense if not paid in full
5. It is always best to pay the entire amount than carry forward amounts from month to month