Credit cards are among the greatest innovations of the financial product and service industry. The security features that have constantly been added make the little piece of plastic very valuable and extremely safe to use.
The safety is less relevant to a shopping addict. The credit card is like a god-gifted boon to the veritable spender—just swipe your card at the counter, stretch your spending power, and take a call on whether you want to repay the whole amount or just a part of it. If that describes you, then you are missing out an important aspect regarding the transparent ‘and’ hidden cost of credit cards.
Like most young executives, Rakesh Joshi, too, was lured by enticing advertisements. An interest-free EMI offer with a waiver on joining and annual fees seemed too good to be true. However, when he started reviewing his bills over a two-year period, Rakesh realised that he was actually paying a steep price for using the credit card. Here are the startling things he found out.
WAIVER OF ANNUAL AND JOINING FEES…
Rakesh realised that the waiver of annual and joining fees was only applicable for the first year. From the second year onwards, the annual fees of Rs 5,000 per annum were charged to his account. For waiving of the joining fee, there was a condition in the fine print that he would have to spend at least Rs 10,000 on an average each month. Since his spend was less than that, the joining fee of Rs 3,000 had also been charged to his account at the end of the first year. Obviously, like most credit card applicants, Rakesh, too, had signed the agreement without reading the fine print.
ACTUAL INTEREST AND PENAL INTEREST…
Credit cards are, by definition, high cost borrowings. The typicalcost of a credit card outstanding ranges from 2 to 3 per cent per month. That works out to a cost of nearly 24 to 36 per cent per annum, which is a huge cost by any standards. That is not all! If in any month you miss your minimum payable by the due date, then penal interest will be charged. This penal interest is roughly 30 per cent of your minimum payable.
That adds another 1.5 per cent to your monthly interest. Most credit card holders do not read the fine print on the penal interest clause and Rakesh was no exception. He realised that he had almost ended up paying interest at 5.5 per cent per month on his credit card spends.
THE HIDDEN COST OF CASH WITHDRAWAL…
Many credit card holders treat their credit cards just like an ATM card when it comes to withdrawing cash. Sorry, you are mistaken! Not only does the cash withdrawn attract interest at 3 to 4 per cent per month, there is also a transaction fee on cash withdrawal. This transaction fee is normally a minimum of Rs 250. Rakesh realised that on five occasions when he had withdrawn Rs 1,000 on his credit card, he had been charged Rs 250 as cash withdrawal fee. So, apart from the interest cost, Rakesh had ended up paying a huge 25 per cent cost for withdrawing cash.
KEEP AN EYE ON THE CHEQUES THAT YOU ISSUE…
There are two very steep costs that you may end up incurring on your credit cards. Most credit card holders typically tend to deposit cheques at the drop box. Ensure that your cheques do not get dishonoured. If that happens, then you will be charged an amount of Rs 1,000 for each cheque bounced. Remember, many credit card companies will also send you a legal notice under Section 144 for cheque bounce cases. The related legal charges will also be debited to your credit card account.
There is also the issue of outstation cheques. For example, if you drop the cheque in Mumbai and your account is based in Delhi, then the credit card company imposes an outstation cheque clearance fee, as well as interest till the amount is received. Most banks issue cheques that are “payable at par” at all their branches. You could avoid outstation charges if you ensure that your cheque is “payable at par” and that your bank has a branch at the centre where you deposit the cheque.
COST OF EXCEEDING YOUR CREDIT LIMIT…
This is something many of us do inadvertently. In the case of Rakesh, he had spent within his credit limit. When the interest was charged for the month, it exceeded the credit limit and therefore a 5 per cent charge was imposed on him as overdraft fee. It is advisable not to use the entire limit available. Keep your credit card outstanding to the minimum possible and always keep a 20 per cent buffer on the upper side.
CHARGES ON SELECT TRANSACTIONS…
There are some additional charges that get debited to your credit card. Certain items like petrol, diesel and rail bookings may attract service charges at the rate of 2.5 per cent. To avoid this cost you can either opt to pay in cash or use a specific petro card or rail card which waives off these service charges. You need to be cautious while using your credit card abroad. There is a currency translation that has a cost when you spend in dollars or other currencies. Additionally, credit card companies levy 2.5 to 3.5 per cent of the value of the foreign transaction as international usage charges. Rakesh only realised this after he went on a shopping spree during his family holiday in Singapore. Above all, remember that your credit card also attracts service tax at 15 per cent and any duplicate bill you ask for will also be charged to you.
Having a credit card is a blessing. You just need to ensure that it does not become a curse, with some diligence while using it. Here are a few pointers:
* Revolving credit has a huge cost. Pay your credit card bill and clear any outstanding as a top priority.
* Never miss a payment date and don’t ever let your cheques bounce. Ideally, prefer an electronic transfer for payment.
* Don’t ever use your credit card like your ATM card.
* Read the fine print before accepting the credit offer.
Rego is CEO and founder of Right horizons, an end-to-end investment advisory and wealth management firm