If you are one of those who can be termed as an impulsive shopper or a reckless spender and have a credit card to go with it, you are at high risk of falling into a debt trap. No, just by having access to credit card is by no means a negative, but having an urge to keep shopping without knowing the pitfalls of credit card expenses can be detrimental to your financial health.
Taking a look at your credit card bill you may have come across the minimum due amount column. The minimum due amount is too lucrative to ignore as the charges are just 5% of your total outstanding credit card amount.
Many card holders often pay just the minimum due balance amount each month but one day the debt and the accumulated interest can become too big for comfort leading to financial stress. Here is a look at how just by paying the minimum due balance alone can be a road to financial destruction.
Understanding minimum due amount
Minimum due amount commonly termed as MAD is typically 5% of your overall credit card outstanding as per your credit card bill. All unpaid amounts from your previous month's bills along with the current month's dues and EMIs of converted purchases are taken into account when calculating the minimum due amount.
Calculation of minimum due amount
Let us assume your credit card statement is issued on the 7th of every month and the last date of bill payment is 28th of every month. So assuming if you make a purchase of Rs. 20,000 on November 15, the amount would be seen in your December bill issued on December 7th. The due date for payment would be December 28th. Now you can choose to pay a minimum due amount of Rs.1000 (5% of Rs. 20,000) without having to worry about clearing the outstanding debt entirely, any late payment fee or any credit score worries.
The biggest reason why many card holders opt for payment of just the minimum due balance amount is that it allows them to keep their credit card account regular without payment of all outstanding dues. It also helps the card holders to avoid any late payment charges associated with their outstanding amount. So while paying just the minimum due amount can be a good idea when faced with a financial crunch, making a habit of using credit card extensively and just paying the minimum due amount can be a recipe for financial disaster.
Why paying just the minimum due amount is a bad idea
One of the biggest reasons why minimum due amount should be avoided is that it cuts out any minimum interest free period offered by your credit card. Considering the above example where card statement is issued on the 7th of every month and the last date of bill payment is 28th of every month any purchase made between November 8th and December 7th will have its due payment date of December 28. So for purchase made on Nov 8th an interest free period of days 50 and for a purchase made on Nov 30th an interest free tenure of days 28.
Now in this case if had opted for payment of minimum due amount and not paid the full due amount in the previous statement, you do not get the benefit of any interest free period. In fact you will now be charged an interest from the date of purchase till the final date of payment. So for the November 30th purchase, interest will be charged for 9 days and will be continued to be charged till you settle the purchase fully.
The financial stress of only paying the minimum due amount each month
Paying just the minimum due amount every month you lose access to any interest free period. The overall cost of the purchase also accumulates making the purchase more expensive with a higher interest payout.
For example for a purchase of Rs. 10,000 your MAD may come to Rs. 500. If you just pay the MAD assuming rate of interest to be 36% you end up paying back Rs. 15499.5 with an interest component of Rs 5499.50 over a 31 month period. Compared to a minimum monthly payment of Rs. 1000 it will take you just 13 months and an interest component of Rs 2067.55 to fully pay your dues.
Conclusion: Minimum due amount may be helpful in times of a financial crisis but making a habit of just paying off the minimum due amount for credit card dues can lead to a financial stress in the long term.
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