How Much Should You Pay On Your Credit Card?

India is one of the fastest growing economies in the world, with a large pool of active credit seekers. The number of credit cards issued in India has been steadily increasing over the last few years. As of September 2021, this number was nearly 65 million credit cards. This increasing interest in fast and easy credit has encouraged credit card providers to introduce new and interesting services and offers.

There are many factors that contribute to the growth of the number of credit card holders in India. The rise of India’s middle class, the sudden economic activity after the pandemic, the change in spending patterns of the younger consumer base, are all top reasons. As per the Reserve Bank of India, the credit card spends in India saw a 57% increase on a year-on-year basis, and was INR 80,000 cr in September 2021.

How Do Credit Cards Work?

In India, credit cards are plastic cards that come with an embedded microchip. The microchip stores information about the credit card account such as credit card number, expiry date and card security code.

Credit cards simplify payment for both buyers and sellers. They allow buyers to avoid carrying large amounts of cash while making purchases. Merchants benefit as they have secure access to funds from customers’ bank accounts, in a documented form, although there is a processing fee involved.

They are widely used everywhere in India, from petrol bunks to restaurants, for hotel bookings, and online purchases. They can be used in person by swiping into a credit card machine or online, entering credit card details into a web form and so on.

There are few places today where it is not possible to use credit cards. For example, some of the smaller shops or restaurants do not accept credit card payments even today, as their smaller scale of business may not make buying and maintaining a card swiping machine viable.

How Does A Credit Card Payment Cycle Work?

Although credit cards are popular and simple to use, they do come with some risks. If not managed cautiously, it is very easy for the user to get caught in a complex cycle of debt. One of the first things users need to do is understand their credit card payment cycle and how it works.

The credit card payment cycle involves processing a credit card transaction from start to end. To understand the process, users first need to understand a few terms associated with the cycle.

• Cardholder: This is the authorized user of the credit card or the person whose name is on the card.
• Merchant: This is the vendor who sells goods or services to the cardholder.
• Issuer: The bank that issues the credit card, usually on behalf of a card payment network, like VISA or American Express, is known as the issuer.
• Acquirer: This is a more complex concept and pertains to the mechanism by which the merchant receives the funds from the sale. An acquirer could be the bank with which the merchant has his account or is usually a third-party system/gateway that interconnects the payment to the merchant’s bank account.

Now let’s analyze a typical credit card transaction.

1. The transaction starts when the customer makes a purchase with their credit card.
2. The merchant then captures the information from the card (from the Point of Sale – PoS machine in case of physical transactions and from the payment gateway in the case of online transactions) and transmits it to the acquirer.
3. The acquirer forwards it to the issuer for validation and authorization.

The entire chain of events from taking money from a customer’s account and paying the merchants for goods or services is called the credit card billing cycle, typically a month. Credit card companies send a statement with the details of transactions done during the billing period to the customer, who then has to make the payment of the amount specified.

How it works:

Understanding the billing cycle is essential for financial planning. In general, the billing cycle for a credit card will last anywhere from 25 to 31 days, depending on the card issuer. Your credit card due date will remain the same every month. It will usually be 21 days from the end of a billing cycle.

A typical credit card billing cycle has the following steps:

• The transaction date is the date on which you spent money from your card account.
• The statement date is when you get a statement from your bank with all the transactions that occurred in this account during this period.
• The billing date is when your bank bills you for any balances or interest accrued since the statement date. 
• The due date is the window after which they will charge interest if payment has not been made.
• The grace period is the time between the statement date and payment due date where interest is not charged.
• The total outstanding is the amount that is yet to be paid by the customer. This includes the amount one sees on the statement, as well as the spends done post the statement date, till date.

For example, let us say the credit card billing cycle is from 19^th of a month to 18^th of the next month, with statement date being 18^th and due date being 7^th of the next month. Also, let us assume that today is the 26^th, and that the customer has made total spends of INR 6000 before 18^th, and Rs.3000 between 19^th and 26^th. In this case, while only Rs.6000 is payable by the 7^th, the total outstanding is Rs.6000+Rs.3000 = Rs.9000, i.e. total amount payable regardless of when it is due.

• The minimum due is 5% of the total outstanding amount you can pay to avoid being marked as credit card default and also keep your card active. While this is the bare minimum to be paid, one is expected to make full payment to avoid penalties. More on that later.

Why is this important? As a credit card user, you need to understand specific aspects of your card cycle for better financial planning. The questions you need to ask to understand your fee structure include:

• What are your payment timelines, and are you usually in a financial position to pay back your debt on the due date?
• Do you make full payment or minimum payment for a particular month? Bear in mind that while minimum payment can be tempting and allows you to keep the card active as your finances recover, repeatedly using this option will lead to spiraling credit card debt.
• What kind of charges are incurred if you delay or miss payments? For more on this, refer to the upcoming section on how credit card companies make money?

How Should You Pay For Your Credit Card?

Credit card companies charge fees to merchants for accepting credit cards for payment, and they charge fees to customers if they fail to pay their bills on time. This is where the trouble starts for most credit card customers.

You sign up for a credit card and receive a credit limit. You can use this credit limit to pay for goods and services.

If you do not pay off your due amount in full, your new balance will include the amount you have borrowed from the card issuer, plus interest, which is calculated at a high rate (as much as 48% per annum) over many months.

Better financial planning is the key:

As a credit card user, how can you effectively ensure you don’t burden yourself with payments and yet manage your finances?

• Understand your savings and expenditures – Everyone’s needs are different. Before signing up for a credit card, you need to analyze your spending and payment patterns and decide which card suits you best according to these habits.
• Understand the terms of agreement – The fine print on the documentation speaks volumes. Speak to the representative or manager and understand hidden clauses, charges and penalties, if any.
• Gain a full understanding of rewards – Credit cards generally offer cash back or points, and sometimes air miles. Once you understand your card’s rewards scheme, you can leverage it fully to get the most out of your purchases.
• Anticipate future cash-flows and capital requirements – Financial planning is an absolute must for credit card holders. A lot of people use credit cards as a means to stall unexpected expenses and remain stuck in a debt cycle, unable to repay it.
• Using the card for needs and not wants – Always bear in mind that credit card issuers charge heavily between 24-48% p.a. on the unpaid bills. Simply speaking, unrestrained use of credit cards can be a sure way to get into a debt trap.

Avoid these common mistakes while using credit cards:

• Using credit cards for cash withdrawals: There is no interest-free period for cash withdrawals on your credit card, so bear in mind that your card should be your last resort when seeking emergency funds. If you do use your credit card to withdraw a cash advance, it needs to be paid off almost immediately. Even then, there is a heavy, cash withdrawal fee applicable, in addition to the interest. Hence, cash withdrawals should be completely avoided.
• Carrying your dues forward to the next cycle: As mentioned before, it may seem extremely convenient to continue making the minimum payment to keep the card active, especially when finances are tight. But this can prove to be an extremely costly mistake, as we saw in the previous sections. The total amount spent is essentially now a loan with atrocious rates of interest.
• Missing payments repeatedly: It is very easy to miss your due date for payment, especially if you are using multiple credit cards. But besides attracting heavy penalties, this can also impact your credit score in the grand scheme of things.
• Opting for unnecessary moratorium: If you have a way of paying off your credit card debt, please do so. It is true that the RBI has given a moratorium on credit card dues to help those people whose finances have been affected by the pandemic. But this is just a temporary deferment and the interest on your outstanding will continue to accrue.
• Applying for new credit cards frequently: There are pros and cons to having multiple credit cards. But, multiple maxed-out credit cards can indicate you are in financial trouble, and negatively impact your credit rating.
• Not scrutinizing your bills: Many people assume that as banks use automated processes for calculations, there will not be any errors in the billed amount. Hence, they do not give the statement a thorough check. Going through the bills will not only give you a better idea of your spending patterns and curb them as needed, but it will also help you identify any theft or fraud that may be happening with your credit card.
• Use the loan facility only if you have no choice: While loans that can be processed on credit cards are quick and pre-approved, they come with higher interest rates than personal loans. So, this is not a great option unless you are confident of your ability to repay the loan on time, and there is no other feasible alternative available to you.

Say yes to credit cards, but tread with caution:

Credit cards can be useful and convenient financial tools if you learn to use them responsibly. Even if you are in financial debt owing to careless use of credit cards, you can take professional advice to gradually become debt-free.

With responsible spending, credit cards can prove to be a valuable financial tool. They can fetch you reward points, discounts on your desired purchases, and in general, defer your payments by over a month, thereby saving you interest. When you are in temporary financial stress, the ease of conducting transactions through credit cards can prove handy.

One of the foremost things you can do is to avoid common mistakes and stay away from unnecessary spending. You must also take the time to understand their card’s fee structure, interest rates, penalties, and rewards. As an additional reinforcement, before finalizing a credit card, you can also approach online marketplaces and advisor forums to compare the different credit cards available to you and determine which is the best fit for your lifestyle.