You own a credit card and have racked up a big bill on the card. Your cash flows are stretched this month and you can’t pay the card dues in full. You have been a good borrower all along and don’t want this instance of unpaid dues to become a blot on your credit records. What do you do?
Firstly, avoid being in such situations. But I know sometimes our hand is forced. However, ensure that you don’t find yourself in such a situation frequently.
Secondly, to prevent adverse reporting to credit bureaus and avoid paying any late payment fee, you can pay the Minimum Amount Due.
What Is the Minimum Amount Due?
Minimum Amount Due (MAD) is the lowest amount you can pay on your credit card bill to keep your account regular, avoid late payment charges and avoid adverse reporting to credit bureaus.
From what I understand, most banks specify 5% of the total outstanding at the month-end as the Minimum Amount Due (MAD). Any EMI payments are charged over and above.
For instance, you spent Rs 50,000 during the previous billing cycle. Also, have an EMI of Rs 3,500 linked to your credit card (credit card expense converted into a personal loan). Then, the Minimum Amount Due shall be Rs 50,000 * 5% + Rs 3,500 = Rs 2,500 + Rs 3,500 = Rs 6,000
What if the Banks Were to Reduce the MAD to 2% of the Outstanding Amount?
Going by this report on Moneycontrol website, Axis Bank reduced the MAD to 2% last year. IDFC First Bank will reduce the Minimum Amount Due to 2% from September 2024.
Continuing with the above example, at 2%, the MAD will be Rs 50,000*2% + Rs 3,500 = Rs 4,500.
In the absence of any EMI payment, the MAD will fall by a good 60%.
I do not know the reason behind such a hare-brained move. This can’t be a feature that you advertise to attract new customers. I don’t think borrowers sign up for credit cards in the hope of paying a lower MAD. I don’t expect banks to make a lot of interest income by reducing MAD from 5% to 2%. If the interest on 95% is not enough, don’t think 98% would make much difference.
The banks also understand that while such borrowers (who pay the minimum amount due) help them generate high interest income, these are also risky borrowers. The chances of default are also higher. Hence, it is a double-edged sword for the banks.
The only reason could be to hide stress in their credit card portfolios. Reducing the MAD can help them kick the can further down the road.
From borrowers’ perspective, I see only one benefit. That you can pay less to keep your account regular, avoid late payment charges, and avoid adverse reporting to credit bureaus. You can keep your account regular by just paying 2% of the outstanding. There is no other benefit. Only problems.
A lower MAD means you pay less. That means you will pay more interest. However, a much greater problem is that it can compromise your spending discipline.
We focus on the short-term. And not everybody may appreciate the high cost of credit card debt when you can pay a very small amount to keep the engine running. 5% was not high enough. 2% is just too low.
When you are paying just the MAD, it is obvious that you are under financial stress.
By reducing the minimum amount due (MAD), the banks make it easier to continue with your reckless spending, opening the gates for even deeper financial trouble.
You must also note, when you pay just the Minimum Amount Due, you lose the benefit of interest-free credit period on your credit card expenses. Hence, you pay an interest rate of 36-45% p.a. from the day you swipe your credit card.
Does RBI Have Any Rules about Minimum Amount Due (MAD)?
Yes, RBI does and there is a small disconnect.
RBI Master Direction on Credit Cards clearly states the following in clause 9(ii):
The terms and conditions for payment of credit card dues, including the minimum amount due, shall be stipulated so as to ensure there is no negative amortization. An illustration is included in the Annex. The unpaid charges/levies/taxes shall not be capitalized for charging/compounding of interest.
For any loan, if you pay your dues on time, the outstanding principal will only go down gradually. Will never go up. However, if you skip payments, the unpaid interest would get added to the principal and the outstanding amount will go up. This is called negative amortization (outstanding amount going up due to unpaid interest).
The Reserve Bank clearly says that the minimum amount due (MAD) should be sufficient to cover the interest cost for the month. If the MAD was not sufficient to cover the interest cost, the unpaid interest cost would be added to the outstanding balance and the outstanding amount will go up due to unpaid interest. That’s negative amortization and RBI says that there should be no negative amortization if the customer continues to pay the MAD.
In other words, MAD should be enough to cover the cost of interest for the period.
RBI follows up with an illustration in the same circular.
The outstanding amount of a credit card account at the end of month A is ₹10,000. Interest is calculated at a rate of 2% per month. Therefore, if the total outstanding is not paid on or before the due date, it would require payment of interest of ₹200 (2% of 10,000) along with tax and other charges of ₹50 (indicative figure) totalling to ₹250 in addition to the outstanding.
The MAD for the month A shall be calculated in a way that it does not result in negative amortization. Accordingly, the MAD shall not be less than ₹250 (indicative figure), so as to avoid capitalisation of interest or other charges in the subsequent statement.
Now, with this RBI direction, if the monthly interest rate on unpaid card dues is 3%, how can the Minimum Amount Due (MAD) be just 2% of the outstanding amount? Because in that case, the MAD may not be sufficient to cover even the interest cost for the month. That would lead to negative amortization, which is not allowed by the Reserve Bank.
There are 3 possibilities.
- I have not understood the RBI directions properly and the rules allow a lower MAD. However, RBI rules on MAD seem black and white. OR
- The banks that have reduced MAD charge a lower rate of interest on unpaid credit card dues OR
- This lower MAD has other caveats that report from Moneycontrol misses out on.
I could not find more substantive information on the respective bank websites. If you use credit card from Axis Bank or IDFC First Bank, you could reach out to find more information.
In any case, if you use credit cards, ensure that you never have to worry about these conditions about the minimum amount due. Pay your credit card bills in full by the due date.