Credit cards are a commonly used payment tool that allows users to borrow money from a bank or card issuer up to a pre-approved limit. When used responsibly, they can offer convenience, fraud protection features and rewards, which may not be offered by most debit cards.
However, many people may not understand that credit cards offer an interest-free period only when the total outstanding amount is paid in full by the due date. Even a small unpaid amount can change how interest is applied on the balance carried forward, as well as on fresh transactions made using the card.
When is credit card interest charged?
Interest charges increase the total outstanding amount on a credit card. Typically, banks levy interest under the following circumstances:
- Delayed payment: If you fail to settle your credit card bill on or before the due date, the card issuer will start applying interest on the outstanding balance amount.
- Making minimum payments: When you pay only the minimum amount instead of the full outstanding amount, the bank charges interest on the balance amount. This will keep adding up until you clear all your dues.
- Partial payment: When you pay a portion of the actual bill amount, credit card interest rates are applicable to the balance amount.
- Cash withdrawal: If you use your to withdraw cash from an ATM, you must pay interest on it. In such cases, the interest is usually higher than the interest applied to regular transactions.
What happens when you miss paying entire balance by due date?
Credit cards offer an interest-free period only when the full outstanding amount is cleared by the due date. Even a small unpaid balance converts the account into revolving credit. Once that happens, interest applies not only on the unpaid amount but also on new purchases from the transaction date, according to Adhil Shetty, CEO of BankBazaar.
Meanwhile, two other experts who spoke to Mint also noted that when this requirement is violated, interest may be charged retrospectively on the full outstanding amount from the transaction date, and not just on the unpaid portion. In addition, fresh purchases made in the subsequent billing cycle may also lose the grace period and can start accruing interest immediately until the entire outstanding balance is cleared.
How interest piles up on ₹100 unpaid due
If a cardholder had an outstanding bill of ₹10,100 but paid only ₹10,000 by the due date, the remaining unpaid amount could lead to the loss of the interest-free grace period, according to Shams Tabrej, Co-founder and CEO of Ezeepay.
Assuming the credit card carries an annual interest rate of 30% (around 2.5% per month), interest on the full ₹10,100 outstanding would amount to about ₹252.5 for the month. If the user also made fresh transactions worth ₹20,000 during the next billing cycle, those new spends may also begin attracting immediate interest, adding another ₹500 in charges.
This would take the total interest to around ₹752.5, with an additional 18% GST on the interest component amounting to roughly ₹135.45. As a result, against a principle outstanding of ₹20,100, the total payable amount could rise to nearly ₹20,988 by the next due date, meaning you would have to pay approximately ₹1,000 extra which you could have otherwise avoided if you cleared all your dues within the stipulated deadline.
“This is a simplified estimate. In reality, interest is calculated on a daily reducing balance, so the exact figure may vary slightly depending on transaction dates,” the expert said.
Are minimum due payments creating a false sense of safety for credit card users?
When you pay only the minimum amount due, you can avoid late payment charges, but the remaining unpaid balance starts attracting finance charges, which can go up to 42% per annum (for most credit cards), according to Santosh Agarwal, the CEO of Paisabazaar.
However, it’s important for credit card users to note that this can happen only if the concept of compounding interest is not thoroughly understood.
“When there is an unpaid balance in your account, all new purchases become ineligible for the interest-free period, which means they will incur finance charges from the first day. This can quickly start a spiral and turn a small overdue into a huge debt, especially if you continue paying only the minimum amount due for several consecutive months,” he said.