The easiest way to make your loan search (and application) easier is to maintain a healthy credit profile. This week, we will learn about one of the most common debt traps, and how to steer clear of it affecting your credit profile negatively.
What are the signs that you are or may be falling in to a debt trap?
How can you avoid falling in to a debt trap?
Let’s start by looking at Credit Cards. Nowadays, most people use Credit Cards. It is a brilliant way to manage your money provided you pay your Credit Card bill on time. By availing a longer credit period, your savings continue to earn at least minimal interest rate (if it is lying with the bank) while you continue to spend. But do make a note of the points below:
• Read the fine print
Before availing any new credit, read the terms and conditions. Taking Credit Card as an example, let’s discuss a few eye-openers:
Interest-free credit period : You may be under the impression that you have 30-55 days of interest-free credit, but don’t forget that this period starts from the first day of the billing cycle and not from the date of purchase (unless otherwise specified by the Credit Institution). You can best utilize this by making most of your purchases at the start of your billing cycle, and thereby effectively using the “interest-free period” to stay clear of the debt trap.
Interest Cycle: In most cases, interest rate is charged from the date of purchase and not from the payment due date in the event of default or payment of minimum amount due. Let’s look at an example. Amit buys a LED TV for 50,000, and a washing machine for 12,000, on the 1st and 15th of January respectively. The due date is 15th February. He misses this deadline. Now, the interest calculation, which can be as much as 36-45% p.a., will be levied along with late payment charges.
So how is interest calculated? It is generally calculated from the date of purchase and not from the due date or bill date. This changes everything! Amit would now be paying interest for at least 45 days on the TV purchase and 30 days for the washing machine purchase. So even though you may think that you missed your payment by a day or a week, your interest liability is much more!
Cumulative Interest : When you are revolving your money, i.e., just paying the minimum due, you continue to accumulate interest charges from the first date of purchase. Whenever a payment is being made, it is being offset against the first purchase. Once that is adjusted, it moves to the next purchase. In short, it follows the FIFO method. For example, if your current Credit Card bill is 10,000, assuming you do not spend further on the card and pay back 500 monthly, it will take you as much as 3 years to pay off the entire amount. For every 100 you spend, you will pay back 175!
• Spend only what you need
You may have read this before but it does not get simpler than this. Follow a simple exercise for a month- track ALL your expenses. Note it down on your phone or at home. When you do this, you will realize where your money is going. Then curtail on the things that you don’t need.
All this affects your CIBIL Score. Not only does your payment history get affected in case of default, but also your Current Balance increases, indicating higher debt.