At the time of medical emergency in her family in January 2007, Nisha Naik used her credit card to clear the hospital bills which amounted to Rs 1 lakh. In such a situation anybody facing such a situation could have done the same.
She being family’s only earning member with no assets to fall back upon, she had to depend on her salary to payback the debt. She had planned to pay off the debt in the following two months, but things did not work out as planned and she ended up paying the 5% minimum due amount till October 2007. By the time she could realize that the money she had been shelling out every month formed mainly the interest component and she still owed the credit card company the bulk of the principal amount nine months had passed. On knowing the reality she quickly applied for a personal loan to clear the credit card dues.
It’s anybody’s conjecture that she would have saved on a lot on her interest outgo had she chosen for a personal loan earlier, which is surely cheaper than credit cards. Says My Financial Advisor director Amar Pandit: “Interest rates in case of personal loans are much lower than credit card loans; generally speaking, personal loans are at least 50% cheaper than credit cards. Depending on the category of employer or whether the individual is self-employed, interest rates could vary from 12% to 23% per annum”.
The other option could have been personal loan on credit card (PLCC). “On the basis of card transaction history, we can also provide a personal loan on the credit card itself,” informs Sachin Khandelwal, head of cards, ICICI Bank. But this carries a processing fee of 2%, as well as foreclosure charges of 3.5%. On the monthly statement it is shown as a transaction entry separately till it’s paid off. This type of loan carries a rate of 16-20% pa whereas credit cards typically have an interest rate of 36-40% pa. There can be variation on interest rate on personal loan from 18% to 21% pa.
“Our recommendation is that if a customer finds that the outstanding amount on his/her credit card is not being cleared in a couple of months, he/she should choose this option. However, if such options don’t help in clearing dues within 12 months, then a personal loan is strongly recommended,” asserts Mr Khandelwal. An important point to remember is while applying for a personal loan the minimum tenure is 12 months and the minimum loan amount is Rs 50,000 (the processing fee for personal loans is 2%).
Usually people make a mistake of not thinking in terms of replacing the high-cost credit card debt with a low-cost one. Though credit cards can be easily acquired and boast of high convenience value, but one should remember that they are strictly meant for short-term purposes and stretching the repayment term will only lead to headaches for you. Hence, set a deadline after which you would start looking for less expensive loans. If you find yourself in a situation of not being able to pay off dues in, say, two months after borrowing on your credit card, then you should opt for cheaper alternatives.
Adds Mr Pandit: “Credit card loans are the costliest forms of loans and I would certainly recommend a person to opt for personal loan. However, even before I do this, I will explore if the person has investments and if he/she can get an overdraft against mutual funds and blue-chip stocks. Generally, this is available in the range of around 11% and should be preferred to personal loan. Same goes for overdrafts on fixed deposits, if any. Here, you pay the interest only for the period the OD is utilised”.
However, since Nisha and her family owned no assets as such, what are the other options that she could have exercised, apart from personal loan, to ensure that her interest outgo was lower? “These days, credit cards offer free rollover for three months, so she could have explored the option of rolling the credit over for three months (without any interest),” replies Mr Pandit. The credit card space has several schemes. For example, banks like ICICI have an option of converting a credit card transaction into an installments-based one — the EMI option. This usually entails a processing fee of 2-4% and the interest rate varies from as low as 0-18% pa.
You can also go for balance transfer schemes, wherein you can transfer the outstanding amount to another bank’s credit card. Under this scheme on the new credit card, for a particular period, you either don’t have to pay any interest or you may be a charged a nominal rate of interest. You can also use such schemes for debt consolidation— you can transfer the credit outstanding on several cards to one card that carries the lowest rate of interest, thereby reducing the interest payable. If you are caught in a situation similar to that of Nisha, it is high time you switched over to schemes that don’t burn a huge hole in your pocket.
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