Rediff News  All News
Rediff.com  » Business » Card tricks: Minimum balance or EMI?

# Card tricks: Minimum balance or EMI?

June 30, 2009 13:07 IST

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:

 Effective Interest Rate for 0% EMI Option with Credit Cards Purchase : Rs.30,000 Term for repayment 9 months 6 months 3 months EMI 3333.333 5000 10000 One Time Processing Charge 3370 2400 1200 Processing Charge % 11% 8.0% 4% Effective Processing Charge Annualised % 14.98% 16.00% 16.00%

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).

 Effects of Paying only Minimum Payment While Paying Credit Card Bills Months Opening Balance Interest charged Tax on Interest Net Amount Due Amount Paid Closing Balance 1 10,000 300 31 10,331 500 9,831 2 9,831 295 30 10,156 500 9,656 3 9,656 290 30 9,976 500 9,476 4 9,476 284 29 9,789 500 9,289 5 9,289 279 29 9,597 500 9,097 6 9,097 273 28 9,398 500 8,898 7 8,898 267 27 9,192 500 8,692 8 8,692 261 27 8,980 500 8,480 9 8,480 254 26 8,760 500 8,260 10 8,260 248 26 8,534 500 8,034 11 8,034 241 25 8,299 500 7,799 12 7,799 234 24 8,058 500 7,558 13 7,558 227 23 7,808 500 7,308 14 7,308 219 23 7,549 500 7,049 15 7,049 211 22 7,283 500 6,783 16 6,783 203 21 7,007 500 6,507 17 6,507 195 20 6,722 500 6,222 18 6,222 187 19 6,428 500 5,928 19 5,928 178 18 6,125 500 5,625 20 5,625 169 17 5,811 500 5,311 21 5,311 159 16 5,486 500 4,986 22 4,986 150 15 5,151 500 4,651 23 4,651 140 14 4,805 500 4,305 24 4,305 129 13 4,448 500 3,948 25 3,948 118 12 4,078 500 3,578 26 3,578 107 11 3,697 500 3,197 27 3,197 96 10 3,303 500 2,803 28 2,803 84 9 2,895 500 2,395 29 2,395 72 7 2,475 500 1,975 30 1,975 59 6 2,040 500 1,540 31 1,540 46 5 1,591 500 1,091 32 1,091 33 3 1,127 500 627 33 627 19 2 648 500 148 34 148 4 0 153 500 (347) Total 6,031 621 17,000 - Notes: Interest rate considered is 3% per month on the outstanding amount. Rs 500 which was the minimum balance for the first month is paid throughout the term Service tax considered is 12% plus 3% surcharge on the tax amount Effective interest rate is 40.69% per annum

BankBazaar.com