Knowing the complex rules used for calculation of credit cards is necessary to get an idea of the damage a late payment can do to your financial well-being. In this article, let us understand how banks calculate interest on credit cards.
How banks calculate interest
Every bank has to disclose the method of charging interest in its Most Important Terms and Conditions (MITC) document. The MITC document forms part of the welcome kit that you get on the issue of a new credit card and must also be available on the bank’s website. The calculation of interest depends on the type of transaction. And speaking of transactions, there are broadly two types as follows:
- Cash advances, i.e. cash withdrawals from the ATM using your credit card
- Regular payments such as paying bills, online purchases, using card at merchant outlets, etc.
Related: How to come out of credit card debt
As far as cash advances are concerned, there is a clear and unambiguous rule that many debt settlement companies will remind you of, that interest will be charged as per the stated interest rate from the date of withdrawal to the payment of the outstanding amount.
However, as regards regular payments, it is slightly more complex. As per the rule, if you do not make the total payment due as on the payment due date, the free credit period shall be ignored and interest shall be charged right from the date of purchase for all payments made during that bill cycle as well as those made after the bill cycle till the full outstanding payment on the card is cleared. And since the interest rate on credit cards is anywhere between 15 – 40%, this precisely is the reason why a small default or late payment can balloon in to a large debt in a small span of time.
Understanding Credit Card Interest Calculation through an Example
Following example can help understand the calculation of interest in case of a credit card:
|Purchase on September 10, 2015||10,000|
|Total Amount Due on Statement dated September 15, 2015||10,000|
|Minimum Amount Due on Statement dated September 15, 2015||500|
|Payment made on Due Date i.e. October 3, 2015||0|
|Purchase on October 7, 2015||1,000|
|Payment on October 10, 2015||5,000|
|Interest calculation @ 40.80% p.a. on Statement dated October 15, 2015 will be as follows:|
|1) Interest on 10,000 for 30 days (from September 10 to October 9)||335.34|
|2) Interest on 5,000 for 6 days (from October 10 to October 15)||33.53|
|3) Interest on 1,000 for 9 days (from October 7 to October 15)||10.06|
|Total interest in the Statement dated October 15, 2015 (A) = (a) (b) (c)||378.93|
|Late Payment Charge (B)||500|
|Service Tax @15% (C) = 0.15 * (A B)||131.83|
|Principal Outstanding (D)||6,000|
|Total due as per Statement dated October 15, 2015 (A) (B) (C) (D)||7,010.76|
While a credit card is a great boon in the form of free credit period and reward points, one should not forget the implications of using it irresponsibly. Rules on interest calculation in case of credit cards are extremely complex and highly skewed against the consumer. A user must formalise himself of the rules to prevent a debt trap like situation.
If you have been given a corporate credit card, it’s essential you exercise even more caution. To ensure you don’t break any rules, here are some Corporate Credit Cards- Dos and Don’ts.
Disclaimer: This is general advice. Please refer to your bank’s MITC document for detailed guidance.