#WhatTheFinance: A Basic Introduction To Credit Cards

I was 18 when my father gave me my first credit card, an American Express add-on card that I could use only in the case of emergencies. I was very excited about that card – I even considered it to be my financial coming of age. Looking back, my American Express card was probably the worst card I could’ve had for “emergencies”, simply because not a single store accepted the card back then.

It’s been a decade since, and I continue to hold the same fascination for credit cards. They’re financial tools that can help your bank account when used right, but when used wrongly, they become the plastic reincarnation of 19th Century Zamindars who tricked people into becoming bonded labourers. How and why does this happen?

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How Do Credit Cards Work?

Here’s how a credit card works – the bank issues the card to you, and when you swipe it in a shop, the bank pays money on your behalf to the shopkeeper. The bank will then consolidate all the times you’ve swiped the card, and issue a bill, which you have to pay. You can either pay the bill in full, or pay the ‘minimum due’ amount.

Watch Out For Interest On Your Credit Card Payments

One of my jobs as a Chartered Accountant in practice is to go through clients’ financial histories. These histories include credit card statements. It is during this process, when I have noticed many smart, intelligent, and accomplished people pay thousands in credit card “interest”, purely because of carelessness, or poor financial planning. The amount is small, initially, but before you figure out what’s happening, it snowballs into a figure that could feed a household for months together. What’s interesting is that most people are completely ignorant of this “interest” charge until it actually figures in their bill, and when it does, they immediately come to the opinion that the credit card company is swindling them.

There is only one reason why interest shows up on your bill, and that reason, is you.

How Do Credit Card Companies Charge Interest?

When you delay paying your bill, or don’t pay the entire amount in full, you will have to pay interest. The credit card company isn’t your magnanimous friend from whom you can just take money from time to time. Your bill is something that you have to pay, and the minimum due is the amount that you absolutely have to pay.

The moment you skimp on your payment, you attract interest.

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WE INTERRUPT THIS POST FOR A SEXY INFOGRAPHIC

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There’s Always A Catch

The rate of interest is also an aspect that confounds many. I’ve had many people tell me that they’ve felt cheated because the credit card company had given them the card by promising “interest rates as low as 2%”, only for them to charge a great deal more when the bill actually came around. You see, the interest rate in most cards is in fact 2%, but, the 2% is by the month, which means that it works out to a whopping 24% a year. Let’s also not forget that the interest isn’t just on the month’s balance which you haven’t paid, but on future transactions as well, until you settle the dues in full. If you delay your payment, you will also have to pay extra charges for delayed payments.

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Here’s an easy to understand example. Let’s assume that you succumb to temptation at the Mont Blanc store, and purchase a diamond studded pen by swiping your card for a lakh of rupees. The bill arrives the next month telling you that you are due to pay a lakh, with a minimum due of twenty thousand. You pay the minimum due a couple of days after the due date, and then go on to purchase a sofa for twenty five thousand the next month. Interest will be calculated (along with GST) on not only the eighty thousand left for the entire month, but on the sofa as well. Apart from this interest, you’ll also have to pay late charges, which is also subject to GST.

One Simple Rule

The good news is that paying interest and finance charges is fully preventable. All you have to do is follow one simple rule: Don’t spend money you don’t have. Use the credit card like a charge card. A simple rule that I follow is to ask myself, would I have been able to put this on my debit card, or pay it through net banking? I swipe my credit card if, and only if the answer is yes. You should also remember to pay your bills in full before the due date, to prevent late payment charges.

When used correctly, credit cards are excellent financial tools. They provide a breathing space to plan your finances. Unauthorised transactions can be reversed in a snap, which means they’re more secure to use online when compared to debit cards or net banking. Some cards even come with benefits (such as airplane miles, or cash back), which can actually help you save more money in the long run. Just remember – With great power, comes great responsibility.

5 Comments

  1. Very well written.I knew nothing about this stuff untill i’ve read this.The articles here are very informative.

  2. To be honest. I am financially illiterate, of course except for the basic transactions. Your articles are very informative and I am beginning to get a grssp. Could you throw some light on PPF savings ?

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