The Reserve Bank of India (RBI) recently asked banks and card issuers to calculate the minimum amount due on credit card bills in a way that does not result in negative amortization. "The unpaid charges or levies or taxes shall not be capitalized for charging or compounding of interest," the central bank earlier said in a master direction – Credit card and Debit card – Issuance and Conduct Directions, 2022. RBI had asked the banks and card issuers to implement this rule starting from October 1, 2022.

Explaining this new rule, Sachin Vasudeva, Director & Head of Cards, Paisabazaar, said, "The new rule requires the credit card issuers to set minimum amount due high enough so that the overall outstanding balance can be cleared over a reasonable period." Moreover, finance charges, other penalties, and taxes that are applicable to the outstanding amount should not be capitalized in the subsequent statement.

HOW THIS NEW CREDIT CARD RULE WILL WORK?

If only you pay the minimum amount due on your credit card bill, then the interest will be charged on the remaining amount and all the new transactions until the previous balance is paid in full. The interest on the credit card outstanding will be calculated as: (the number of days counted from the date of transaction x outstanding amount x interest rate per month x 12 months)/365.

Let us say your bill date is the 10th of the month and on the 1st of the month, you spent Rs 1,00,000. Your due date is the 25th of the month and you pay the minimum amount due of Rs 5,000. Now, for the next bill, the interest would be calculated on the outstanding Rs 95,000 for 40 days, which is the time from the date of the spending to the second bill date.

If you continue to pay only the minimum amount, then each month, the interest will be calculated on the interest. "In case the outstanding amount is very high, it is possible that the interest generated over a few months would be more than the typical minimum amount payable of 5 percent outstanding balance. In this case, the interest payable will accrue on the credit card and bloat the outstanding amount. Moreover, the customer would be paying interest on interest, without the outstanding reduction. This is an example of negative amortization," explained Pankaj Bansal, CBO, BankBazaar.com.

When the minimum amount due on the credit card is set too low, it does not help the customer in completely paying off the debt. "Instead, the principal increases over time even on making minimum payments regularly. This is because finance charges and other penalties keep adding up in every billing cycle," said Vashishtha. If a customer keeps paying only the minimum amount due every month, the outstanding amount will keep increasing in the previous scenario.

As per the new RBI rule, the card issuer may charge a higher minimum balance, say 10 percent of the outstanding instead of 5 percent, to ensure that the minimum payment covers the interest accrued on the outstanding amount as well as contributes towards the principal, Bansal added.

HOW MUCH MINIMUM AMOUNT DUE ON YOUR CREDIT CARD DO YOU NEED TO PAY EVERY MONTH?

The minimum amount due on a credit card should be greater than or equal to the accumulated interest and charges due, and not just as a function of the principal balance outstanding on the credit card, said Amit Das, CEO, and Co-founder of Think360.ai.

For example, the outstanding amount of a credit card account at the end of the month is Rs 10,000. Interest is calculated at a rate of 2 percent per month. Therefore, if the total outstanding is not paid on or before the due date, it would require payment of interest of Rs 200 (2 percent of 10,000) along with tax and other charges of Rs 50 (indicative figure) totalling Rs 250 in addition to the outstanding.

The minimum amount shall not be less than Rs 250, to avoid capitalization of interest or other charges in the subsequent statement. However, a decent amount should also go towards repayment of the principal to clear dues in a reasonable time.

"The exact minimum amount depends on your outstanding and your credit card issuer's rules," said Bansal.

SHOULD YOU PAY ONLY THE MINIMUM AMOUNT DUE ON YOUR CREDIT CARD?

Unless there are strong reasons as to why you are not able to pay the full amount due, a customer should always pay their complete bill on time, said, experts. In case of an emergency, it is okay to pay only the minimum amount due, but it should not be a habit.

"When you pay only the minimum due, the remaining balance starts attracting finance charges which can range from 2 percent per month to 3.5 percent per month or even higher in some cases. Moreover, when there is an outstanding balance on your card, new transactions also become ineligible for the interest-free period. Hence, it is advised to always pay the total dues instead of the minimum amount," said Vasudeva.

If a customer foresees that he will not be able to pay the total amount due before the due date due to a financial crunch, he should convert the outstanding amount to equated monthly installments (EMIs) with a significantly less interest rate.