
Member • Dec 14, 2007
Credit Cards - Understanding the basics
Credit cards originated in US in 1940s. There was a diners card where the card holder could dine at any of one of the chain of restaurants and could settle the bills later. The card had the information of the user and was a way to identify the members of the diners club. The same idea then evolved and today we have sophisticated credit card systems.
A credit card is nothing but a type of loan, called as revolving credit in banking terms. Every credit card has a ‘credit limit’ that is the maximum amount up to which the card holder can spend money (i.e. avail credit). For example if your credit limit is Rs. 50,000 then you can use your card to purchase up to Rs. 50000. After you have used up your limit you cannot use the card further till you have paid back some of the credit amount. Now if you pay back Rs. 10,000 of the Rs.50,000 then you can further purchase for Rs. 10,000 using your credit card but not more than that. In short at any point in time you will not be allowed to avail credit more than your credit limit.
Credit limit is calculated on the basis of the credentials of the card holder, i.e. his monthly income, his profession etc. which are the indicators of his ability to pay back. No bank wants to lose out on money so its important that the banks calculate appropriate credit limit for a customer. Also unlike other loans in credit cards banks do not have any collateral (i.e. security for the money that is lent by the bank) , so banks have to be prompt and careful while issuing a credit card to anyone.
Once you have a credit card, you can use it at any outlet which allows the use of credit card for payment. You just have to swipe your credit card at the Point of Sale machine and the bank on your behalf will do the payment. You will receive the bill for the same at the end of your billing period (read on for explanation) and then you have to pay your bill. The bank doesn’t charge you any interest what so ever if you pay all your dues within time. But the interest rates are extremely high (2-3% per month i.e. 24-36 % p.a.) if you don’t settle the dues in that billing cycle only. For example , if your credit card bill is Rs. 20000 and you pay all of 20000 then you are not charged any interest. But if you pay only 5000 and choose to pay the remaining in the next cycles then interest will be charged on the outstanding Rs.15000.
Billing cycle is nothing but the period for which the bill will be generated. For example the credit card is issued to you on 1st of the month then your first bill will be generated on the last day of that month, and all your credit card transactions carried out during that month will be included in that bill. You will receive the bill after that and will have some time to pay off the bill before the bill due date. You have to pay some minimum amount of the outstanding dues on the bill due date.
Lets consider a billing cycle for Mr. X from May 1st to May 31st. Suppose Mr. X buys groceries worth Rs. 2,000 on 1st. Then on 5th he buys a Handy-Cam worth Rs. 18,000 using his credit card. Then on 30th he buys a TV for Rs. 15,000 and on 2nd June he makes a payment of Rs.5,000 towards his insurance premium using the credit card. Now the last transaction that is the insurance premium payment will not be included in the May billing cycle so the bill that will generated on 1st June. Mr. X will get this bill by 7th of June and will still have some time before the due date. This cycle will have the due date (i.e. the last date till which the bill can be settled without late fee charge) as 20th June. Now consider the first purchase made on 1st May , Mr. X pays for it after 50 days (on the due date 20th June) and he is not charged any interest at all. Thus with credit card one can have interest free loans (obviously within your credit limit) for a period of up to 50 days. Similarly the insurance premium will be billed in the June cycle and Mr. X will have to pay it till July 20th. Now a days one can even adjust one’s billing cycle as per one’s convenience. Suppose I get my salary on 10th so I will adjust the billing cycle such that my due date will be 12th so I keep my billing cycle from 22nd –21st . In order to avail maximum interest free period I can make all my purchases on 22nd so that I get 50 days to pay off my dues.
Thus credit cards offer you the luxury of credit without interest for 50 days. You don’t have to carry any cash with you just swipe a credit card and forget about the payment till your due date. The most interesting part is that you get some points for the amount spent using the credit card and then you can redeem these credit card points for gifts. So if used judiciously credit cards offer you the luxury or credit with gifts and discounts. But if you miss some payment then you will be charged very high interests and significant amount of late fees. So just be careful while you make your purchases.