Card tricks: Minimum balance or EMI?

Buying things using plastic has graduated from being a lifestyle statement to one of becoming a necessity in recent years.

Today's tools

Travel on any express train and we can see the number of online tickets beating the old form of counter tickets by at least 4 to 1. It would be dumb to say 'Don't use credit/debit cards.' Cards are similar to television sets, mobile phones, computers and the Internet which are technological advances/tools that are now an integral part of our lives.

But the issue is that these tools have taken over so fast that many of us have not had the time to think of the best ways to use these tools.

Effective use of credit cards

The best way to use a credit card is to pay the full amount specified in the bill before the due date. That way we get close to one month's credit (sometimes more) from the card company.

There may be some charges in certain places for the usage of the card. If there was any during the month, most of the time the credit advantage gets nullified (goes back to zero).

Beware of impulse purchases using the credit card, they can run up a bill that we may not be able to pay when the bill comes in. The credit card companies grow in double digits (and survive at bad times) because of such purchases.

Pitfalls of using credit cards

So what do we do when the purchase is beyond the repayment capacity? We are presented with 2 options:

• Pay the Minimum Balance, or
• Convert the purchase into an EMI.

Both these options are negative from the perspective of the purchaser. The better option is to pay as much as possible so as to close the purchase amount in a month or two (and not purchase anything in the meantime)

Paying the Minimum Balance

The table provided at the bottom illustrates the effect of paying only the minimum balance on the outstanding. See how long the term gets extended to and also the total amount (Rs 17,000) paid for a small principal (Rs 10,000)

The most important output from the table will be the effective interest rate. This is the interest rate charged on us when we pay off Rs 10,000 over 34 months buy paying Rs 500 monthly. The effective interest rate in this case is 40.69% per annum.

Is it worth it to pay such high effective interest rates to purchase anything? Think not.

Converting the purchase into EMI

This is another seemingly good idea. The plan is to convert the purchase say Rs 30,000 into an 'interest free' EMI (Equated Monthly Installment). On the surface the deal sounds too good to be true, and we jump at it before the tele-caller (who usually offers the deal) thinks otherwise.

The tele-caller goes on to say that there is only a one-time service charge of some low percentage, the rest of the amount is totally free.

Let us the do calculation for one such offer:

Thus we can see clearly that the zero percentage is not truly Zero, but a cool 15 per cent to 16 per cent more.

Conclusion

This is article is not suggesting that the credit card companies are the big bad wolves out there to get you. Used well, the credit card can be a time saver (train tickets), face saver (just short of cash after a candle lit dinner with your girl friend) and a life saver (imagine carrying Rs 100,000 cash in an unknown place!). After all, a popular ad goes is there a price for the smile on your parents' face?

The way out of the darkness surrounding the usage of credit cards is through awareness and knowledge -- awareness of our buying / spending patterns and the knowledge about the various terms of use of the cards (time to dust up the pouch in which the card arrived or better ask the company for a new set up or if lucky your company may be among those who print the terms of use behind each bill).