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Intelligent Guide To Credit Cards: Part 1

Written by CreditSmart

You Have A Pocket Full Of Credit Cards, But Do You Know How They Actually Work?

Everybody needs help with plastic money, for it is easy to be careless with it or ignorant about certain facts about it. The key is to learn quickly, and put in practice what you learn.

Here are the detailed answers to four most common questions, three related to credit card loans and one to improving credit score, to help you use credit cards more smartly.

Question 1 – More and more people are opting for credit card loans. Why this is so? What is the exact process with regards to loans obtained on credit cards? What’s the usual interest rate and how it is calculated?

Answer – True, many people take credit card loans. The main reason behind this trend could be lack of documentation required for a credit card loan. It can be availed more easily and quickly than other loans.

Lack of documentation, however, doesn’t mean credit card companies do not plan for risk. Just like in case of other loans, in credit card loans, too, lenders extend a loan offer only to those with a positive repayment history.

Credit card companies don’t ask for your documents only because they already have them. When you took a credit card, you also shared relevant documents with them. They are also aware of your complete credit history, so are in a good position to accurately evaluate the kind of risk you as a borrower present to them.

Typically credit card loans are for a time period between 6 to 48 months. Most have a time period of 12 to 24 months and usually the loan amount is not too high.

Rate of interest on personal loan is in the range of 16% to 24%, which, as per most financial experts, is not very high. However, the trick here is that the repayment happens in form of easy monthly installments or EMI.

The EMIs to pay are added to your monthly bill, that is, on top of the transactions for which you’d used your credit card last month, you’d also have to pay that month’s EMI. Now, if you pay the bill in full each month, there’s no problem. Then, your effective interest rate would be between 16% and 24%. However, most times, most people choose to revolve credit—and this is when the interest starts to pinch a lot. In this case, in addition to the interest rate of EMI, you’d have to pay additional interest, which is in the range of 30% to 36%, because of the revolving credit.

Here’s an example to explain this better. Let’s say in January you take a personal loan. In February, the bill statement will include the actual bill for various transactions for which you used the credit card in January, plus the EMI for January. In case you make the complete payment, you are absolutely fine. You’ll pay an interest of 16% to 24%. However, in case you revolve credit, paying only a small percent of the bill and deferring the rest to March, you’d end up paying the EMI amount, which has an interest component of 16% to 24%, plus 30% to 36% interest on top of that. In addition to this, you’d also have paid a processing fee, which usually is 2% to 2.5%. In case of prepayment too, you’d have to pay some extra charges, plus service tax. So, effectively the interest comes up to 40% – 50%.

Question 2 – How does taking a credit card loan affects my credit rating? Does it affect when I default? How does a future lender will interpret my action of taking a credit card loan?

Answer – When you take a credit card loan, it immediately shows up on your CIBIL report. Its showing up there, however, doesn’t impact your score. Your score gets affected, and gets affected pretty badly, when you default.

Even when a credit card loan by itself is not reported negatively on the credit report, a future lender will see it negatively—and not without good reasons.

A pure personal loan usually has an interest rate of 16% to 20% percent. When a pure personal loan is available by submitting documental proof at a low rate of interest, why would a person want to opt for a credit card loan which has a much higher rate of interest? Obviously, he’s in some desperate situation, wherein he needs financial help without delay.

This fact doesn’t escape lenders, and if there’s one thing that they don’t like to see in potential lenders it is desperation—because that means financial instability or approaching financial instability. Lenders prefer borrowers with a sound repayment history and whose financial situation is not out of their control.

Read Intelligent Guide To Credit Cards: Part 2 HERE

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