The credit trap of paying the monthly minimum

It may be tempting to just pay the monthly minimum due on your credit card statement. After all, it helps with your cash flow. Unfortunately there are consequences of paying just the minimum each month – you will incur interest charges and it will take you longer to settle your outstanding balance.

The result? Huge debts in a short time frame. At present, most card issuers impose a finance charge of 1.5 per cent per month, which is charged on a daily basis and compounded monthly.

You read earlier in this book about the effect of compound interest when you save your money. Compound interest also applies in this situation, where interest is paid on the principal amount plus the accumulated interest amount owing.

It is important to realise that the longer you take to settle your credit card debts by making minimum payments, the more money you will owe. With high interest rates, you will end up paying more money to the card issuer as compared to the original amount you paid for the product or service.

If you made only minimum payment each month — namely five per cent of the outstanding balance — over time you will have a huge outstanding balance. The credit card issuers are required to include the illustration below on paying only the minimum amount in the last credit card statement of each year.

Pay as much as you can, as early as possible, so that you clear your credit card debts earlier and the interest you save can be put to better use, e.g. retirement savings.

Paying credit card balance in full

Remember to always pay in full your outstanding credit card balance- this will enable you to enjoy an interest free period of about 20 days for all your transactions. However, if you only make partial payments you will lose your interest free period.

Tips on using credit cards

1. Pay the amount due in full when you get your monthly statement to avoid paying interest.

2. Do not use a credit card if you cannot make the monthly payments.

3. Limit the number of credit cards you have.

4. Do not use your credit card to get cash advances from an ATM. Each time you use your credit card to withdraw money, you are increasing your loan commitments in addition to paying upfront withdrawal charges and daily interest.

5. Pay before the due date to avoid late payment charges and penalty rates.

6. Be aware of the consequences of paying minimum amounts all the time.

7. If you have a cash flow problem, pay the minimum amount for the present but pay the full amount as soon as possible.

8. Always check your credit card monthly statement to ensure proper transactions and charges are recorded. The statement includes your transactions, any fees and charges, the due date of payment and the minimum payment. Call your card issuer if there is anything wrong with your statements, or you have not received it.

Credit Bureau

The Credit Bureau of BNM has been in operation since 1982. It collects credit information on borrowers, including private individuals, businesses (sole proprietors and partnerships), companies and government entities, and supplies the information back to financial institutions.

The Credit Bureau keeps information in the Central Credit Reference Information System (CCRIS), which is a computerised system that automatically processes credit data received from financial institutions and synthesises these information into credit reports. These reports are made available to financial institutions on request.

Each time you make a new application for a loan, the financial institution will check your payment history with the Credit Bureau. They will use the information to decide whether to give you a loan or not.

Other than the Credit Bureau, there are also privately-owned companies that provide their clients, including financial institutions, with information on a borrower’s repayment record and status of legal actions, if any.

Keep a copy of your CCRIS report to track your loans with financial institutions and monitor your loan and credit card repayment pattern. You can check whether you have a healthy repayment schedule and defaults or late payments appearing in your report.

If your CCRIS report indicates late repayment or default, a financial institution has the option of denying any new loan applications because it indicates that you are not managing your loans well or you have financial difficulties.

It pays to be a good paymaster because this will be reflected in your credit report. In fact, effective July 1, 2008, you are rewarded for being prompt in your credit card payments – financial institutions will impose finance charges on a tiered basis depending on your repayment behaviour.

Defaulting on loan payments and failing to settle your credit card debt can have terrible consequences.

You will be sued by the lender. Your car or property will be auctioned.

Your family members will be affected because they may have to help in paying your debts. Your loan guarantors, if any, will also suffer because legal action can be taken against them. You may become a bankrupt.

You will suffer emotionally due to stress. You will be getting constant calls and letters from lawyers and lenders to demand that you settle your debts. In such situations, you can become unproductive and your work or health may be affected.

The Credit Counselling and Debt Management Agency (AKPK) is an agency under Bank Negara Malaysia tasked to help individuals take control of their financial situation. For assistance, please contact AKPK’s Power Infoline at 03-26167766 or visit www.akpk.org.my.

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