Credit Card: Understanding Interest Charges
A credit card is a flexible and useful tool, either as a means of payment or as an alternative source of funds at times of emergencies. While credit cardholders can reap benefits from its usage, it is very important that users understand how to utilise credit cards responsibly. This also includes understanding how interest on credit cards is applied and calculated. This article aims to provide users with guidance on how to make good use of your credit card, and to better manage its usage.
Disclaimer
The examples in this article are for illustration purposes only.
Credit cardholders are encouraged to check with their respective financial institution on how interest rates on credit cards are calculated. For example, some financial institutions may charge interest on credit cardholders on a daily rate.
Note: For Islamic banks, administration fees apply as opposed to being charged with interest.
Transactors vs. Revolvers: The Different Types of Credit Cardholders
| Transactors | Revolvers |
|---|---|
|
Transactors tend to pay their credit card bills in full. They are therefore perceived to have a lower level of credit risk, overall. For example: Hussein bought groceries worth BND250.00 using his credit card, but pays the balance in full when the bill comes. |
Revolvers carry an outstanding balance from month to month. They are generally perceived to have a higher risk of defaulting, especially when they accumulate a significant amount of unpaid balances. Therefore, revolvers need to ensure that they pay their outstanding balances on time and be extra wary of compounding interest and late payments fees. For example: Siti bought a new computer costing BND1,200.00 using her credit card, but only pays the minimum amount due when the bill comes. |
Act Responsibly: Avoid the Consequences of Late Repayments!
Lowering your chances of getting a new loan
The Credit Bureau collects, compiles and consolidates both banking and non-banking (such as utilities) information to generate an individual/ company's credit score and subsequently, the credit report for the individual/ company. With these tools, financial institutions are able to make credit assessments on an individual's loan application. Credit cardholders with irregular repayments will be seen as high risk, and this may lead to financial institutions being less inclined to grant them new credit facilities.
Understanding "Compounding Interests"
Compounding interest refers to the interest on top of the initially charged interest which individuals are required to pay on top of the outstanding amount from their credit facility. Furthermore, a late fee is usually incurred for payments made after the due date.
For example: Abu bought a new laptop costing BND1,000.00 using his credit card. Assuming he does not make any repayments at all and the interest charge stands at 1.5% per month and his late payment fee is fixed at $40.00 per month, the amount he is due to pay will be as follows:
| Scenario: No Repayments Made | ||||
|---|---|---|---|---|
| Month | Opening Balance | Interest @ 1.5% | Late Payment Fee | Amount Outstanding |
| January | BND1,000.00 | BND15.00 | BND40.00 | BND1,055.00 |
| February | BND1,055.00 | BND15.83 | BND40.00 | BND1,100.83 |
| March | BND1,100.83 | BND16.66 | BND40.00 | BND1,167.49 |
| April | BND1,167.49 | BND17.51 | BND40.00 | BND1,225.00 |
| May | BND1,225.00 | BND18.37 | BND40.00 | BND1,283.37 |
| June | BND1,283.37 | BND19.25 | BND40.00 | BND1,342.63 |
| July | BND1,342.63 | BND20.14 | BND40.00 | BND1,402.76 |
| August | BND1,402.76 | BND21.04 | BND40.00 | BND1,463.81 |
| September | BND1,463.81 | BND21.96 | BND40.00 | BND1,525.76 |
| October | BND1,525.76 | BND22.89 | BND40.00 | BND1,588.65 |
| November | BND1,588.65 | BND23.83 | BND40.00 | BND1,652.48 |
| December | BND1,652.48 | BND24.79 | BND40.00 | BND1717.27 |
| Total | BND237.27 | BND480.00 | ||
After a year, Abu's total accumulative outstanding credit card balance will have shot up from BND1,000.00 to BND1717.27 – almost double the amount he initially owes. Therefore, it is to make your repayments to avoid these unnecessary charges. You will also be saving your money!
Financial Tips to Better Manage Your Credit Cards
Budgeting and self-control
- Use your credit cards wisely, preferably only for emergency purposes.
- Track your credit card spending against your financial capacity.
- Budgeting and knowing your needs and wants will help you from overspending.
Know your due date
- Keep track of your repayment due dates and ensure monthly obligations are paid on time to avoid unnecessary additional charges.
- Any outstanding balance including interests that are not cleared by the due date will be compounded in the next payment statement.
Pay above the minimum amount due on a timely basis
Following the above example with Abu, the table below shows the difference should he pay the minimum amount due (8%) or above the minimum amount due (15%).
Assuming Abu only pays the minimum payment on a monthly basis, he would clear his debt in 24 months, summing to a total of BND1,305.88. On the other hand, assuming that Abu pays 15% of the outstanding amount, he would clear his debt in 16 months, with total payment of BND1,160.24
| Scenario | Payment 8% of the monthly outstanding | Payment 15% of the monthly outstanding |
|---|---|---|
| Initial Debt | BND1,000.00 | |
| Interest rate on outstanding amount | 1.5% per month | |
| Time taken to pay off outstanding | 2 years or 24 months | 1.3 years or 16 months |
| Total amount paid eventually | BND1,305.88 | BND1,160.24 |
This example shows that paying above the minimum amount due means would lead to clear of debt quicker and also at a lower total amount.
Pay your credit card bills in full and on time once you receive your bill
A normal billing cycle is usually 28 to 31 days, with a grace period between the end of a billing cycle and the payment due date. As such, when the opportunity arises, pay your credit card in full before the end of the grace period as it will prevent you from incurring any interest charges.
Take note of charges incurred using the cash advance facility
Credit cardholders are also advised to be extra wary on utilizing the cash advance facility on their credit card as interest charges are incurred instantly after withdrawal. Charges using this facility are often incurred on a daily rate, causing outstanding balance to accumulate very quickly.
Bottom Line
There is absolutely nothing wrong with owning a credit card as it acts as an alternative emergency source of funds aside from cash savings. However, it is important that credit cards are used responsibly. If you are interested in signing up for a credit card, ensure that you speak to a sales representative of your preferred financial institution to understand information such as credit card payment due dates, fees and charges that you might incur, as well as penalties for non-payment.
For more information, please contact the Financial Consumer Issues of BDCB here and follow BDCB's Instagram