How to repay your credit cards instantly

In my last article I explained everything about credit cards and how easy it is to fall into the debt trap. If you haven’t read it, go and read it first. Two basic things should be obvious from that article:

  1. Interest Rates on credit card debt is one of the highest ever for an individual
  2. Paying just the minimum balance every month will take you years to clear off your debt and you lose a lot of money by paying interest.

We will take the same example of a credit card having an outstanding balance of Rs.1,00,000 and 3.25% interest rate per month. Lets also assume that your salary is not enough to repay the entire debt in a single month after all the expenses.

So you were paying only the minimum balance of Rs.5000 per month. But you saw that it will take 33 months to repay the entire debt. What if you wanted to repay it sooner? For that to happen there are two factors that play a role here:

  1. The bank should reduce your interest rate (Yah! like that is going to happen so easily)
  2. You pay slightly more than the minimum balance every month. With a little bit of proper budgeting, this is easier to manage and is within our control. Lets take 3 examples and see how each works out.

Lets take 4 possible scenarios:

  1. You are only able to pay the minimum balance of Rs.5000 per month.
  2. You are able to pay 10% more than the minimum balance. So instead of paying Rs.5000, you can pay Rs.5500 per month.
  3. You are able to control some of your expenses and can pay back Rs.10,000 per month. Double of your minimum balance.
  4. You got a raise and also cut down on your expenses. Now you are able to pay back Rs.20,000 per month.

You can plug in these numbers in one of the numerous calculators online or can check out this graph that I drew with the calculations already done.

Amount vs Time taken to pay
Monthly Amount vs Time taken to pay
Option Monthly Payment Num of Months Interest paid
A 5000 33 Rs.64,133
B 5500 28 Rs.53,711
C 10000 13 Rs.22,924
D 20000 6 Rs.10,972

This shows that even a small 10% increase in the monthly payments helps a lot by saving you 5 months and more than Rs.10000 as interest paid to the bank. If you have credit card debt make sure that you are putting in as much money as you can into your monthly payments.

What about very large outstanding balances?

There are numerous people who got too deep into the credit card debt trap, that it would take them many years to finish repaying their bill. What to do in those cases? Here are 7 ways that you can get out of your credit card debt almost instantly.

Credit Card Repayments

1) Break your savings/investments

If you have money lying around in your savings accounts or fixed deposits, break them and use that money to repay your credit card bill. Your fixed deposits might earn you 8% per annum. But remember your credit cards are making you lose 39-42% per annum. You will definitely be profitable by paying off your debt first than not breaking your fixed deposits.

Also remember it doesn’t have to be just FDs, but it could also be money that you have invested in mutual funds or bonds, etc. As long as you keep losing money servicing your debts, any investments would give you a net negative return on your networth.

2) Take a loan from friends/family

If you have a good relationship with friends or family, you can take a small loan from them to repay the bill first. Most friends/close family would give you money for zero or very low interest rates. Even if you agree to pay a bank FD rate to them, they would be profitable and you also would get a loan at much lower rates than banks.Win-Win situation to both parties. Also, it is easier to convince a close friend or family member.

3) Take a personal loan from your bank

Go to the bank with whom you have a good relationship and talk to the manager to get a personal loan for the amount you have to repay. The interest rates for personal loans are much higher than what you can get a friend to agree to, but it is definitely lower than a credit card debt. Personal loans are at a rate of about 16%-20% per annum and you end up paying half the interest rate than a credit card.

If your credit report is bad and your CIBIL score is too low, you can go for a secured loan. You have to give a collateral to the bank and get a loan. You can also try gold loans or top-up loans if you have a home loan already.

4) Convert Credit Card debt to EMI

Most banks gives you the option to convert Credit Card debt into EMIs which has a much lower rate than the APR – usually 13%-16%. You can also chose to convert it to an EMI immediately after purchase and you also get different repayment tenures like 3/6/9/12/24 months.

5) Balance Transfer to a different Card provider

Lot of banks provide a balance transfer facility to get new customers. All you have to do it become a new customer with a bank and the new bank will pay off your old credit card fees and will transfer the outstanding balance to your new card account. And as an incentive for you to join a new bank, they give interest free period of few months and very low interest rate for initial 6 months.
Eg: SBI offers a 0% interest for 2 months or a 1.7% interest/month for 6 months. Depending upon your balance to be paid and your repaying capacity you can choose whichever plan suits you.

6) Negotiate a lower interest rate

Remember I said lowering the interest rate means you get to pay back sooner? You can go to your bank and explain your financial situation to the manager and try to negotiate a lower interest rate. You have to convince them that you are willing to pay and intent to do it fully within a few months once your financial situation gets better, you can shave off a few percentage points off the interest rate. It is a long shot, but you can try it.

7) Credit Card Settlement

If all else fails and you think you can never completely pay off the entire balance, you can go in for a settlement. You have to go to your bank and negotiate a settlement amount (which is lesser than the outstanding amount). Once you pay off the settlement amount, your balances are cleared and you are free to go. Except this involves the bank reporting to CIBIL about the settlement and it will severely affect your credit score. Always use this as a last resort.

Be warned, all these are solutions only if you are unable to repay the balance easily. These solutions shouldn’t give you some sort of safety net to get into the debt trap.

3 Golden Rules to using a credit card

Always remember these 3 rules when using a credit card:

  1. Never spend more than you can afford.
  2. Pay your credit card bill at least 3 days before due date. Better enable auto debit facility from your savings account so you don’t have to remember it.
  3. Never lose money by paying unwanted interest rate to the bank. Remember no one has ever become rich by losing money.

Understanding Credit Cards and the debt trap

Credit cards! The smell of a freshly pressed plastic card is like a drug to many. Young people these days spend money using the credit card like it is real cash. They don’t realise that it is a loan that you take from your bank and you are supposed to pay it back with interest (a really high interest rate too).

As of October 2016, there were 2.73 crore credit card holders in India and with all the excess cash in banks due to demonetisation and cashless transaction drive by the Government, this number would increase a lot as banks will now try to give more credit to it’s customers and people get comfortable with online shopping.

credit cards

But first let us understand how credit cards work and the different terminology used.

Interest Free period

Credit cards are a great way to buy stuff without paying the entire amount on the day of purchase. The banks also give the customers a interest free period per month of upto 50 days. To understand that, lets say your credit card bill gets generated on the 5th of every month and your pay-by date is 25th of the same month.

You are buying a TV for Rs.1 lakh on the 6th of January. The seller has delivered the TV and the bank has also paid the seller the money. You haven’t paid the bank yet and your bill will be generated on the 5th of February at midnight. On 6th February morning you will get an Email and SMS about your bill amount of Rs. 1 lakh and that you need to pay it by 25th of February.

As long as you pay the entire amount of Rs.1 lakh on or before 25th February, you have practically gotten free money from the bank for 50 days. Neat right? This is a great way to handle urgent needs and cash flow crunches.

credit card statement
My own credit card statement

I have taken the example from my own credit card statement. The only difference is the amount payable.

Also what is the credit limit? This is the total amount that the bank allows you to spend. Do remember that this isn’t what your spending limit is. Your spending limit is based on how much you can repay and how much you really want to buy. And available cash limit is how much cash you can take out of the card from an ATM machine.

What happens if you keep paying only the minimum balance?

In your credit card statement you also notice in big bold letters that your minimum balance is just Rs. 5000 per month. So you bought something for Rs. 1 lakh and you just have to keep paying Rs. 5000 per month and you would have fully paid it off in 20 months right?

WRONG!

The bank gives you money as loan or credit and for that facility you have to pay the bank an interest. The bank calls that Revolving Credit Facility where as long as you pay the minimum balance for the month, you wouldn’t get into (too much) trouble. Problem is the interest rates these banks charge you.

Interest Rates

Credit cards have the highest interest rates of all the loans/credit that the banks give, because it is an unsecured loan, you don’t submit any collateral to the bank while applying for one. When the bank sales person comes and sells his credit card plans notice how he would say the interest rate is a very nominal (I hate that word) rate, typically something between 2.95% to 3.5%. What they wouldn’t clearly explain is that number is the interest rate you would pay monthly and the annual percentage rate (APR) is that number multiplied by 12. That translates to 35.4% to 42% per year.

APR vs APY

That interest rate x 12 months = APR is a nice and easy number to calculate and the banks usually mention that in their Schedule of Charges section of the brochure in a 10 pt font. But the people who run banks aren’t stupid. Unlike most of us, they know and understand compounding like the back of their hand. APR is just simple interest and doesn’t take it account the power of compounding.

Compounding is a way for the banks to earn more money from your spendthriftiness. To know how much you are really paying, you would have to understand something called the Annual Percentage Yield (APY), also known as Effective Annual Rate (EAR). So the APY will always be slightly higher than the APR.

To understand the difference between APR and APY, lets take a very nominal (there’s that word again) interest rate of 3.25% (which is the average you would be getting as a new customer).

APR: This is easy. 3.25×12 = 39%
APY: We have to use the Compound Interest formula for this.
= (1 + monthly interest rate) ^ number of months in a year – 1
= (1 + 0.0325) ^ 12 -1
= 1.0325 ^ 12 – 1
= 1.467846 – 1
= 0.467846
= 46.78 %

Wow. Look at that number. There is a world of a difference between the APR and the APY. No bank ever tells you this. Who in their right mind would say you would be paying nearly 50% as interest rate every year? Thats why banks stick to the monthly interest rate or the APR (which is a relatively smaller number).

It only gets worse when you have a balance to be paid on your card and are making more purchases. All purchases when you have a existing balance on your card doesn’t get to enjoy the interest free 50 day period. You have to pay interest the day you make the purchase.

Coming back to paying the minimum balance of Rs.5000 per month, can you guess how many months it will take to pay off all your credit card bill at a nominal 3.25% monthly rate?

Frickin’ 33 months.

And you would have paid Rs. 64,133.20 as interest to the bank along with the original principal of Rs. 1,00,000. You have paid Rs.1,64,113.20 for that TV by not properly using your credit card.

This is of course assuming you haven’t made any extra credit card purchases in that 2.8 years, which is very, very hard. If you add more purchases, your outstanding balance keeps increasing and you would be caught in a never ending debt trap.

This is what many people using credit cards don’t understand and end up losing a lot more than they can earn.

Always remember, the first rule to getting richer is to NOT LOSE MONEY. And misusing your credit cards is a really easy way to lose a significant chunk of your net-worth. In my next article I will be writing about how to get your credit card loans fixed and not lose any more money.

Update: Read the second part of this article – How to repay your Credit Card Debt instantly.