Understanding Credit Card Interest Rates
The reason credit card interest is higher than other forms of borrowing is simple, it is unsecured, unlike a mortgage for example, banks have no security when they lend you money, if you default, it can be difficult for them to recover the outstanding loan amount particularly if you have no assets to speak of. For that reason the interest rate they charge you for this kind of lending is going to be substantial and you should be aware of a few things before you opt to undertake this form of borrowing.
Unsolicited Credit Cards
First of all if you are the recipient of an unsolicited card, that is to say you have not explicitly agreed be issued with one and the card is activated, you should return the card immediately. The Reserve Bank of India (RBI), India’s central bank, has issued guidelines which effectively ban this practice. Unsolicited cards should be returned to the issuing bank, any charges incurred for activating of the card, annual fee’s etc, must be automatically reversed and the bank is obliged to pay you the consumer a penalty of twice the charges incurred (whether that extends to purchase made using an unsolicited card I am unsure as of now, the guidelines do not mention this specifically and are ambiguous on this point). The RBI has asked credit card issuers not to levy excessive charges and to prescribe ceiling rates, including processing charges. The central bank has also said that banks will have to bare any losses arising out of unsolicited cards that they issue.
Credit Card Interest Rates
Now assuming you have signed up and agreed to be issued with a credit card in India, do not be misled by benign monthly rates of interest. Lenders like everybody else like to put their best face forward, and show you monthly rates of interest that seem quite low to begin with first, ranging anywhere from between 1.5% to 3.5% per month. Don’t be fooled by this, on the face of it, looks like a good deal, but due to the power of compounding your annual rates of interest, in India they range anywhere from 36 to 49 % for the average borrower compared to 10-18% for the average borrower in the UK and US. The rates being quoted here are for the average, some individuals in America with poor credit histories can end up paying exceptionally high rates.
Annual Percentage Rate (APR)
A much better measure of what your rate of interest works out to is the Annual Percentage Rate (APR) banks are obliged to quote what their monthly rates of interest work out to on an annual basis and the APR gives you an indication of what this will be. APR still does not provide a completely accurate estimate of the actual interest you would end up paying on a stable balance over one year, that is actually termed Effective Annual Rate (EAR). To arrive at that requires a mathematical calculation using formula which is beyond the scope of this discussion. APR provides a reasonable estimate with which to compare credit cards and is a useful proxy for trying to work out what your interest payments amount to over a year. Stick with that to begin with and according to RBI guidelines all banks are required to quote it. If you don’t know what it is for your card ASK, and be mindful that banks vary interest rates over time to reflect credit conditions in the market place.
Interest Rates on Cash Advances and Purchases
The other thing you should be aware of is banks will offer two rates of interests one for cash advances that you take using the card and the other for purchases made, so if you plan to use your card to finance some activity which is not a retail purchase, then you will be charged in all likelihood a higher rate of interest.
How do Banks Calculate the Balance they Charge Interest On?
Well that can be a difficult one to answer because there are a few methods. However most issuers charge interest based on the average daily balance, which is calculated by adding each month’s daily balance and dividing that number by the number of days in the month.
This is all fairly basic information, but as Indians we aren’t used to looking at the fine print when we seek out credit financing. Most of the time we are concerned with the amount of credit that is available to us, rather than its cost, and that is the reason for the high default rate in this country and why our rates of interest are so much higher then the developed world. A little education will save everyone a lot of time and a lot trouble. Know your interest rate, know your rights, and enjoy your life.
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An interesting post Sharat.
I’ve only ever had a debit card and have often been confused by the terminology used by credit cards companies.
This is a nice breakdown of what you actually need to know when looking to sign up for a credit card.