Friday, March 6, 2009

The real cost of credit cards



LET’S say you have an outstanding balance on your credit card of say RM100. And you just forgot to pay your bill on time. What do you think your charge will be on an annual basis? Would you believe 10,000%?

The answer is very illuminating but you have to read the fine print to find out. I just did when I saw a late payment charge of RM40 on my bill because a payment of RM4,000 was late by a few days.

First, you have to pay up to 18% a year on the outstanding amount. Second you pay a charge of 1% or RM10 on the outstanding amount the moment you go beyond the repayment deadline. You have 20 days free credit but only if you pay on time. Otherwise, it is 18% from the date of purchase even if you choose to pay in instalments plus your penalty charge if you are late.

Let’s say you are late by a week, which is very normal for a lot of people – in other words, by a week you failed to pay a minimum 5% of your outstanding amount or RM5 in our example of RM100.

For that one-week delay on that RM100 outstanding you pay the minimum charge of RM10. Let’s calculate the charge in percentage terms per year. That’s 10% (10/100X100) for one week or 520% (52x10) for one year, not compounded! Total interest charge: 520+18 or 538%. You pay RM10 because you are late with your instalment payment of RM5 and you still have to pay that instalment.

But hang on a second? Are we calculating this right? No, it’s not quite accurate – in fact we have made a terrible, horrible mistake. You see, you are being charged RM10 on the RM5 instalment that you did not pay on time, not on your outstanding balance of RM100 on which you are already paying 18% a year.

Yes, it’s becoming mind-boggling. If you are a week late, you pay 200% (10/5X100) a week or 10,400% (200X52) a year!! I don’t often use double exclamations but you must admit that it is deserved here.

Oh, I can hear what the banks say – the RM10 is a minimum charge. But you don’t need a minimum charge in this age of computerisation when the machine does the calculation with no people involved in the automatic generation of the charge.

Perhaps you think that’s an extreme example. Let’s take my case of an outstanding sum of RM4,000 for which the late payment charge is 1% or RM40. I think I was late by less than a week but let’s just say it was one week. My minimum payment is 5% of RM4,000 or RM200. The RM40 is 20% of RM200.

That 20% a week translates to 1040% a year, not compounded. If I were a mere day late, it would be 7300% (20X365 days in a year).

I have heard the argument that the late payment charge should be imposed to encourage people to pay the minimum amount and maintain discipline for using credit cards. I suppose then one has to believe that banks will play this role well when they stand to benefit more the more miscreants there are. I prefer to suspend belief.

My bank, a large foreign bank with a long presence here shall remain unnamed because it will be unfair to single it out, but it tells me in the small print that the interest rate on outstanding amounts is 18% a year. But it omits to explain how much in percentage terms its late payment charges (1% or RM10, whichever is higher) on a yearly basis are.

Here’s what I suggest and I hope Bank Negara and the Association of Banks will pay attention. Late payment charges are punitive especially when you are already paying punishing interest rates of up to 18% a year.

So simply do away with the late payment charge and charge the interest, as long as I am under my credit limit. If I have just RM1,000 outstanding on a credit limit of RM80,000 should I be charged for not paying the minimum monthly maintenance? No! I should be penalised only if I go above my credit limit.

If banks still want more, give them the liberty to charge higher rates for outstanding amounts not already paid as required by instalments, a more punitive rate of a reasonable 25%, on the minimum instalment not paid

Let’s see what I would have paid if that was done. I was a week late on RM4,000. But if I had paid 5% or RM200 of it, there would have been no punitive rate. So I would pay 25% a year on RM200 for one week. That works out to 96.15 sen, yes sen. (200x25/100/52), instead of the RM40 I paid.

Really, charging a penalty of RM10 because I missed my instalment of RM5 or even RM25 just is too much. So is having to pay up to 7300% a year in charges because I was late in payment.

And while Bank Negara is looking at these things, perhaps they should take a closer look at the entire penalty rate system and see how bad they really are.

It baffles me how such high charges were permitted in the first place.

l Managing editor P. Gunasegaram has no doubts that credit cards are the worst form of legal financing.

No comments: