Just as there is a way to get into delinquency, there is a way to stop and ultimately get out of it.
Advent of credit cards is one of the innovative inventions in banking and finance. One of the criticisms is that it encourages unplanned or impulsive spending. However, the fact is that benefits of a credit card far outweigh the disadvantages.
If the balance of the card is paid in full each month, no interest or financing charges are levied. But if the total balance is not paid, banks will charge full interest on the entire outstanding balance from the date of each purchase.
For example, if any user made the payment of Rs 1,000 and repaid it in full within this grace period, there would be no interest charged. However, if even Rs 1.00 of the total amount is left unpaid, interest will be charged on Rs 1,000 from the date of purchase until the payment is done. The interest is charged on a daily outstanding balance basis and as high a 36 – 42% per annum and it cannot be disputed as usurious rate in the courts after the amendment of banking laws in 1988 about commercial interest charged by banks. Banks, in addition to interest, charge refinance charges every month if the dues remain unpaid. If the card is not paid in full or only the MAD (Minimum amount due) money is paid over a period, the entire card limit will be exhausted by interest and finance charges.
Credit card offers various benefits to the users such as:
# Cash less transactions offering safety
# Reward points and cash backs with almost every transaction
# ATM cash withdrawals from any bank ATM at low cost
# Interest free credit for purchases up to 40 – 50 days
# Convenience of payment
# Personal loans at nominal rates either against unutilised credit limit or based on track record
# Easy conversion of big-ticket purchases into manageable EMIs.
# Can also be used abroad
# Improve CIBIL score with timely repayments.
# It offers revolving credit facility and with good track record the credit limit is normally increased with no additional formalities.
# If one has more than one card, offers transfer of balance facility at 0% interest till the grace period.
While payment of minimum amount due may result in interest and finance charges, it does not impact the credit standing of the user. However, delayed payments will impact credit scores and non-payment of dues for three months or more will have serious consequences like withdrawal of card facility, severe reduction in credit scores and initiation of legal and other recovery initiatives.
Non-payment or Delinquency is graded in levels, indicating how many payments the cardholder has missed. These levels are often referred to in terms of days. E.g., the day after you miss your first payment, you are one day delinquent. After you skip your second payment, you are 30 days delinquent and so on.
If for various reasons like loss of employment, ill health etc., if one were to miss payments for more than 90 days, his card facility will be withdrawn, and the bank will start recovery proceedings. The poor credit score will restrict the ability of the card holder to raise funds from other banks also. This is a double whammy for the delinquent card holder. But, just as there is a way to get into delinquency, there is a way to stop and ultimately get out of it. Making one least payment stops the progression of delinquency and keeps you at your current delinquency level. This is important because the card issuer may report you to credit rating agency, but may refrain from coercive recovery or legal action.
There are many mistakes a card holder does and get into trouble. Let us look at them.
Mistake 1. Paying Less Than the Minimum Payment
Payments less than the minimum amount due does not avoid actions as defaulter since it has no effect on overdue and it is almost as if no payment at all was made. Thus, when you pay a little bit thinking that it will improve your situation, it provides no benefit at all. If only you make credit card payments greater than or equal to the minimum amount required, you can avoid this trap.
Mistake 2. Paying Only the Minimum amount Due
Many people confuse the minimum amount due with the total amount due that appears on their bills. The amount due is the total figure that you must pay to clear your liabilities in full and is likely comprised of multiple minimum payments. So continue making payments until you have paid the full amount.
For example, when you make one minimum payment, your overdue status does not worsen. If you make two, the overdue position will improve. For instance, if you are 90 days overdue, paying amount equal to two minimum payments will bring you to 60 days. In order to get out of delinquency completely and become current on your account, you need to pay the total of all your missed minimum payments plus the interest and finance charges and the current month’s minimum.
Mistake 3. Seeking waiver of interest or settlement of dues by partial payment
While banks may be happy to oblige for a settlement to avoid lengthy litigation, it is not advisable for two reasons. The settlement or waiver brings down the score very much and the resultant poor score may not be acceptable to banks and future borrowing from banks at cheaper rates will be lost. To improve the score is very difficult and may take as long as ten years. Secondly, any remark of settlement or waiver in your credit report make banks wary to extend any further credit in any form as it not only gives an impression of financial irresponsibility and inability to pay debts but also as wilful default.
Once your liability is only current bill, you should work to reversing the ill effects of default. Delinquency is a black mark on your credit report because it signals consumer irresponsibility or inability to pay. This can be reversed only in future and continuous good record of prompt payments. Ultimately, you will not recover from the effects of default overnight. This will take both time and regularly responsible credit card use.
Some tips to use the card wisely and improve your credit score and also to enjoy a high credit standing with the bank are:
# Have only minimum number of cards
# Avoid impulsive purchases
# Do not use the card over the limit
# Pay the bills within the due dates
# Do not use the cards to draw cash from POS
# Do not indulge in fictional purchases to generate cash. This will lower your standing and the hidden cost is very high.
# Do not keep transferring balances between one card to another, if you have multiple cards
# Avoid too many add on cards – it will make it difficult to track spending and you may lose control
# Check the bill carefully and if any discrepancy in it raise it immediately with proof.
# Never use your card for others to buy: the liability is yours and a default by them will become yours. Moreover, this reduces the available credit for you and may force you to go over the limit which is not encouraged by banks.
Once you come of over dues, you must dilute the negative information reflected in your credit reports and re-earn the trust of lenders by showing to them that you can handle credit without getting into trouble.
Use credit cards nicely, but wisely!
(By Gulshan Kumar, Director, ITM Business School, Chennai)