Credit Cardology Part 2 – How Credit Cards Work.

I had initially planned to include this in Part 1 (Read) but this better be treated as a separate unit. This is part 1 explained in more detail, Credit Cards explained, especially on HOW people wind up in Credit Card debt. This is the master plan, folks. The Blueprint for World Domination. The flawless plan of action which can tie up people in little knots with no way to get out.

Disclaimer: Nothing given here are trade secrets. Everything is worded out clearly on Credit Card 'Terms and Conditions', maybe you shuld read them. You wind up in debt because of your own stupidity. You can't blame anyone or anything. From a business point of view, I consider credit cards brilliantly designed products.

Just three product features that make Credit Cards the dominating income source for banks and the number one reason for many a personal tragedy (stupidity aside). So even when you think you have got it all figured out, you will be heading into a vortex where they will have you by the balls (applies for both genders).

1. Interesting Rates - Atrocious and Grows on you!

Interest Rates on Credit Cards do not make any sense in any financial plan, except in the plans of banks when they designed said rates. Paying 40 to 50% as interest is just plain stupid even if it is Atlantis you are being offered. Coming to think of it, there rates are way much more than charged by any traditional money lending 'blade' sharks. And it is not just the rate of interest that makes the difference, but the way it is calculated as well. Presenting: The nut-number formula!Yes, you pay interest for EVERY SINGLE DAY (Interest Rate above is monthly). And interest rates range till 4.15% per month (which is 49.8 - Yes, you pay 50% interest per year!) and it is NOT 20000 x .5 = 10000. Credit Card Interest calculation is not rocket science. Illustrated example below. Pretty much self explanatory. What you will have to remember is that interest is calculated for every day the outstanding is live.

1. Outstanding from previous month (21497) is charged interest till payment date (Apr 1)
2. New spends before payment (3875) are charged interest till payment date.
3. On payment receipt, all outstanding will be added up (21497+3875) and payment* subtracted from it (-5000). So payment date is sort of 'intermediate interest calculation date'.
4. Remaining outstanding (20372) will be charged interest till next statement date (Apr 23)
5. New spends (730, 632, 6731) will be charged interest for number of days till statement date.
* Payment subtracted will be the amount after deducting interest charges, service tax etc.

Golden Screw. Just Saying.

Rs.739 is not so bad huh? Well, remember you are paying Rs.739 for no reason. And if you would note the outstanding has become Rs.28465, for which you will be paying Rs.1012 in interest next month (assuming no payment is made). After a year, you will have thrown away around Rs.50,000, the cash you could have used for a 3 days holiday in Mauritius! Think about it.

Statement Shock: Most users will have a fixed thought in their minds: Payments made will shave off that much outstanding in it's entirety. This will never happen. You can make a payment of Rs.5000 on a Rs.20000 outstanding, swipe it a couple of times (low value) and in the next statement you expect Rs.15000 and there comes Outstanding Rs.19000! Voila! Statement shock!

Any card with an outstanding will need to have a complete STOP on it's spending if you want your interest not to increase and your payments to take effect. In the end, you will come to a state where you realize:

Throwing money into a Black Hole? Yes, you are JUST GIVING AWAY MONEY!

2. Interest's Interest comes first. Always.

You keep on making payments but there is hardly any dent in your outstanding? Another simple rule: This one is about the way payments you make is used to clear off what you owe: Use Payments to clear interest charges first so interest will be earned and ultimately the outstanding will be kept high. So once you make a payment, that cash will be used in the following way: First, Interest will be cleared. Then cash borrowed (if any). Then EMIs (if any), Then Service Tax. And at the end your actual purchases will be paid for from whatever is left (if any :))

Another illustration: Imagine you have an outstanding of Rs.20000 for the last three months. You make a payment of Rs.2000 (10%). 1000 of that will go into interest and tax payments, and the remaining will be accounted against your purchases. So your balance will be 19000. Next month: Rinse again and repeat. Provided you will not purchase anything more using the card, which of course you will. So, Again,

Throwing money into a Black Hole? Yes, you are JUST GIVING AWAY MONEY!           

3. Minimum Balance: The Magic Figure.

"Hey, I do make my minimum balance payments every month. That will be enough, no?” No. All banks advice customers to make more than the minimum payment whenever possible. Minimum Payment Amount (MPA), usually 5% of your outstanding, is a figure designed to make sure that payment will cover the Interest charges, service tax etc. So if you pay ONLY your MPA every month, you will do very little to reduce your purchase payments, and at the same time ensuring that your interest payments will remain high (As per Rule 2). So for a MPA of Rs.1000 for a Rs.20000 outstanding, you might reduce just around Rs.200 from the outstanding! And it will take you YEARS to pay off the entire thing!

For laughs, you might also want to see this hilarious take from It is all true, unforunately. Which brings us once again to:

Throwing money into a Black Hole? Yes, you are JUST GIVING AWAY MONEY!

Your Payments Go In There.

Apart from these, there are other 'alluring factors' like metal named cards to give you a sense of 'exclusivity': Forget it. They are handing out 'Titanium' and 'Platinum' cards as if they are prepaid SIM cards. And paying annual fees for credit cards is just heights of stupidity which should not be left unpunished. Oh and then there are the 'Rewards'. For instance, you need to spend Rs.25,000 to get a Shoppers Stop voucher for Rs.500. Worth it? No? Thought so.

Users who are frusturated that their outstanding is not reducing, tend to forget

  • The less you pay on your dues, the more you are screwed.
  • Any purchase on a card with outstanding balance will have a huge impact in the long run.
  • Even very low value purchases on a card will screw up your entire repayment plan
  • Payments will be useless unless you stop purchases ENTIRELY
  • Paying off 'little by little' will not help. Only Hurt.

Ultimately you will have thrown away tens of thousands of bucks as interest (or even lakhs) for no value, benefit or reason at all which will be several times the valule of the product/service you had bought. And the chick whom you wanted to impress with all this spending would have left you by now seeing the sorry broke state you are in.

As we all know, there is no use on crying over spilled Vodka. There is always hope for redemption. Can you get the Banana Corporation that your life has become back on track? More coming up in Part 3. Stay Tuned!

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  • and how much this the person selling credit cards mention. and think of people with multiple cards!

  • Arvind

    I have 5 cards which i have been trying to pay & finish off for the last 7 months ! Alas ! :(

  • @wise: They dont mention. People will run off! In fact, even the Terms and Conditions are mentioned so that people dont read them!

    @Arvind: I know how you feel! Keep at it and dont lose hope.. Concentrate on one card.

  • pradeep

    look at other side of the coin bro……….. CC company has to survive

    growing no. of defaulters………which is a gross loss in their books

    like any other business, banks will also look for profits….. and dont be surprised, that many have shut down this business due to huge loss!!!!!!!!!!!!!!! even after charging 50%

    above all RBI is regulating the business and they know the dismal performance of the banks

    you cant blame either side completely ………… ofcourse both are screwed

    but ya! as u say its a black hole seriously………. once trapped u r jammed for ever, unless some one bails u out……

  • Pingback: Credit Cardology Part 3 – Use and User Lifecycle (Chart) « Banana Corporation, Inc.()

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