When you know that you have overspent your credit card, your first instinct is to relieve yourself of your guilt by paying the minimum amount due on your card. Making minimum payments on credit cards may indeed seem tempting when you are low on cash, but by doing so you are only increasing your future financial troubles. Making the minimum payment on your credit card not only results in a low CIBIL score. Here’s how:
You pay higher rate of interest
Credit cards are the most expensive form of credit. You pay anything between 28-36% as interest on your credit card annually. Over and above this, if you pay only the minimum amount due each month, your interest rate is compounded each time. This compounded interest continues to add to your outstanding balance in each billing cycle, thus amounting to a sum which may ultimately take you many years to pay off. Thus by avoiding full payment each month, you inadvertently end up paying much more by way of interest than you had originally intended.
Future usage of card becomes difficult
When you are only making the minimum payments on your credit card, you may need to use your credit card for other purchases as well. This is a financial disaster because it means that your debt component is becoming bigger and bigger. Your debt component will comprise of previous purchases+ interest rate+ compounded interest on remaining balance+ current purchase+ interest on current purchases. As a result, you can max out your credit cards sooner than you think. Thus if you intend to continue to come up with a repayment plan for your outstanding balance as soon as possible.
Higher credit utilisation
When the total amount of debt you are using keeps growing, it means that the total amount of credit you are using, as against the total credit made available to you is high. In financial parlance this is called credit utilisation. A high credit utilisation of 50% and above has a direct negative impact on your score resulting in a low CIBIL score. Hence it is financially prudent to keep your credit utilisation below 30%.
How to avoid a debt trap:
Make full repayments in each billing cycle– In the above points we exemplified how making minimum payments on your credit cards are harmful to your finances in more ways than one. Thus it is prudent to make repayments in full each month, so that there is no rollover debt.
Pay as much of outstanding debt as possible– If you have already overspent and your credit card bill shows that you cannot make the entire payment at one shot, do not stop at the minimum amount only. Paying as much as your pocket allows you over and above the minimum amount due will help you keep the compounded interest low, and will help you get rid of your debt sooner.
It boils down to the basics– Finally, do not spend more than you can afford on your credit card. As rudimentary as it sounds, this is the very first rule of credit card usage. From the very first day you start using a credit card, it will serve you well to bear in mind that you should spend only the amount each month that you think you can repay within one billing cycle.
Maintaining basic financial discipline as mentioned above, will help you avoid a debt trap and keep you from damaging your score in the long run on account of your credit card. On the contrary, by following the steps mentioned above, you can build good credit history and get access to cheap and timely credit, when you are in need of the same.
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