The risk of paying just the minimum

Beware of the pitfalls of settling only the ‘minimum amount due’ on your credit card bill

Using a credit card for your purchases is exciting, thanks to the interest-free credit of up to 50 days, ease of doing transactions, reward points, discounts and cash-back offers. In addition to these benefits, credit card companies also allow you to defer your liability by paying only a portion of your monthly outstanding due, called minimum amount due (MAD).

MAD, which is 5-10 per cent of the total outstanding due, is the minimum amount you are required to pay to maintain your card account in good standing. Paying MAD provides a breather at times of cash crunch and helps in getting away with the late fee and penalty, charged in case of non-payment of dues within the cut-off date.

At the same time, extensive use of MAD impacts your credit score, increases interest costs and restrains you from getting interest-free credit benefits.

Impact on credit score

Credit information companies such as CIBIL and Experian evaluate credit utilisation of an individual before assigning a credit score. Credit utilisation is the ratio of outstanding dues to the credit card limit. For example, if the outstanding amount due on your credit card — with a limit of ₹40,000 — for May is ₹20,000, your credit utilisation for the month is 50 per cent. Generally, credit utilisation of 40-50 per cent is considered ideal.

When you pay MAD, the balance of the outstanding due for the month will be carried forward and clubbed with the next month’s outstanding amount. Take the above example; say, the bank allows you to pay a MAD of ₹1,000 for May (5 per cent of the outstanding amount), and you spend ₹15,000 using your credit card in June.

Now, the total amount outstanding for June will be ₹34,000 (₹20,000 - ₹1,000 + ₹15,000), plus interest charges. Here, the credit utilisation for June is more than 85 per cent. Frequent high credit utilisation rates indicate that you are highly dependent on your credit, and thus will lower your credit score. It’s a no-brainer that a lower credit score categorises you under undesirable high-risk profiles.

High interest costs

Paying only the minimum amount on your credit card every month could stretch your dues over many years. It can also lead to high interest payments. Even if you pay the minimum amount before the due date, the bank will charge interest on the balance unpaid amount till the time you clear your entire outstanding dues.

The interest rates after the expiry of credit period varies from 1.5 per cent to 3.5 per cent for a month, or up to 42 per cent a year. The point to note here is that this interest will be charged from the date of transaction/date of generation of statement, both of which are prior to the due date.

For instance, if you spend ₹10,000 and pay back exactly the MAD (subject to a minimum payment of ₹100) every month, it will take you up to eight years and six months to pay back the total amount, assuming that the MAD and the rate of interest are 5 per cent (of the outstanding) and 3 per cent per month, respectively. In this case, just the interest amount will be around ₹11,000, about 110 per cent of the principal amount.

Meanwhile, you might also breach your credit limit on account of higher interest charges. In such cases, you will be further charged with an over-limit fee which could be 2-3 per cent per month.

No interest-free credit

Another problem of paying just the minimum amount is that you will lose the benefit of interest-free credit on your future purchases. That is, till the balance outstanding due on the credit card is repaid, any purchases using the credit card will attract interest charges, even if the total outstanding (including new purchases) is within your credit limit.

What can you do?

When you use your credit card, spend only what you can repay in full by the due date. If you think you will not be able to this, you can look for other financing options such as loans. They are a better alternative as the borrowing costs are lower than the charges on defaulting credit card payments.

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