Here’s how your credit card debt can pile up
Premium- Many investment advisers suggest that if you have credit card dues, you can take another loan to repay the outstanding instead of rotating it
Credit cards can lead a user into a debt trap if he/she doesn’t understand how the issuer levies interest on the outstanding balance.
Many are aware that credit card interest rates (annual percentage rate or APR) are high, and it can typically range between 39% and 42%. But credit card companies also charge interest on interest, leading to a debt trap.
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3 min read . 14 May 2021Credit card issuers charge an interest rate on monthly outstanding. Suppose a person has ₹1 lakh dues, and the credit card company charges 3.5% monthly interest or 42% APR. In the first month, the user pays ₹5,000. Of this, ₹3,500 will be interest payment, and ₹1,500 will be towards payment of principal. After the first month payment, the new balance will be ₹98,500.
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The issuer will charge a 3.5% interest rate on the new balance. This way, the card company charges interest every month on the outstanding balance, and the user ends up paying interest on interest.
To understand how the credit card interest rate is different from the regular loan, let’s compare it with a personal loan with the same interest rate and equated monthly instalment (EMI).
If a borrower takes ₹1 lakh personal loan at 42% for two years, the EMI will be ₹5,287. The borrower will pay a total of ₹1,26,891 at the end of the tenure, which means the interest paid in two years is ₹26,891.
Suppose the same borrower has ₹1 lakh credit card outstanding, and the APR is 42%. The monthly payment is the same as the personal loan -- ₹5,287. It will take the borrower about three years to finish the debt. The total outgo will be ₹1,66,727. The money paid as interest, therefore, will be ₹66,727.
Besides adding interest, the credit card company also levies 18% Goods and Services Tax (GST) on the interest portion in this case, which is considerable. In the first year, the GST will be above ₹600, gradually reducing as the balance reduces.
Therefore, many investment advisers suggest that if you have credit card dues, you can take another loan to repay the outstanding instead of rotating it.
(Do you have personal finance queries? Send them to mintmoney@livemint.com and get them answered by industry experts)
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