27 MAY, 2022

Equated monthly instalments or EMI have become a popular household phenomenon these days. The main reason for this is the availability and convenience with which one can avail of exclusive loan facilities that are affordable to repay. Whatever be the reason for your loan – home, education, or personal, lending institutions have made the lending and borrowing process quite hassle-free. Financial planning is clear and convenient with options like loans against credit cards and tools such as loan EMI calculators. 

 

One must optimize these financial tools to calculate their monthly outflow, based on the loan amount and tenure they have opted for. The EMI changes based on the principal amount, rate of interest, and tenure fixed by the lending institution.

 

A proposed way to repay a loan is through credit cards. There is still an ongoing debate about whether it is advisable to pay a loan using a credit card.  

 

What does it mean to repay a loan using a credit card?

A loan, when issued with specified EMIs for a particular tenure, need to repaid every month. These monthly instalments can also be paid using your credit card. This is what it essentially means to repay the loan using a credit card. This should be reserved for situations where you do not have immediate funds available or a one-off situation.

 

The key concern that arises when you pay using your credit card is your credit card limit. If you cross that threshold, either the transaction will decline, or a penalty fee is charged. The more you charge to your credit card, the lesser the limit availability.

 

Secondly, the credit card interest will be higher if you do not clear your bill before the due date. A credit card will give you some leverage where time is concerned but that is only till the due date. The EMI you have charged to your credit card will start accruing interest after the due date. Credit card interest rates will invariably be higher than the loan interest rate. 

 

However, if you are clear about your financial position, this is still a better and more convenient option than taking yet another loan to repay the previous loan. If cleared before the due date, it has a manageable interest rate and gives you some additional time to pay the EMI interest-free. 

 

Calculating the EMI for a Credit Card Loans

There is no special formula to calculate the monthly outflow when paying using a credit card. Whether you take a loan against a credit card, a personal loan, a house loan, etc., the formula is the same for EMI calculation.  

 

This is the standard formula to compute an EMI on a specified amount is:

EMI = [P x R x (1+R) ^ N] / [(1+R) ^ (N-1)]

 

Here, P is the principal amount borrowed from the lender

R is the rate of interest charged by the bank. This is not the annual rate interest rate but the monthly figure needed to calculate the EMI.

N is the 'tenure' or the time needed to repay the loan. This is also in months. 

 

Let us understand this with figures. Assume that you need a personal loan of Rs. 5,00,000 from a lender. They give it to you at a 15% interest rate, and you need to settle it within two years. 

P = 500,000

R = Interest rate needs to be monthly – 15/12 = 1.25% 

N = Tenure needs to be converted to months – 2 X 12 = 24 months

 

 Put these values in the above formula: 

EMI = [ 500,000 x 1.25/100 x (1+1.25/100) ^ 24 / [ (1+1.25/100) ^ 24 – 1]

= 24,243

The monthly EMI for a loan of Rs. 5,00,000 for 2 years at a 15% rate of interest is Rs. 24,243.

 

Is it beneficial to pay this loan EMI through a Credit Card?

Using a credit card is an option, especially if you do not have the funds or liquidity to pay the loan EMI. A credit card becomes ideal because it buys you some till its due date. As long as you are repaying this before the due date, you are buying yourself those extra days free of charge. 

 

The issue arises when you cannot repay the EMI and miss the payment. The figure then gets added to the subsequent month's bill. It does not end there; this accrued amount is subject to a rate of interest that is substantially higher than the loan's original interest rate. This escalated interest rate ranges from 22% to 36% as it includes both the loan interest and the credit card interest rate. 

 

To use a credit card to repay your loan, use it wisely. Understand your credit card limit, and know that adding the EMI every month to your credit card will reduce your available credit limit, which, if crossed, can incur a penalty. Pay within the due date from the bull generation to avoid high-interest rates and penalties. 

 

As for the benefits, you can easily repay loans as it does not require any additional documentation and is an instant loan repayment process. It is a handy solution when you are low on funds to pay your loan EMIs. To default the actual loan repayment, adding it to the credit card when your EMI is due, is a good option. 

 

Essentially you are taking the bank's money to repay their money. This is because a credit card is essentially a short-term loan. However, if used prudently, it won't pose a problem as long as you clear your credit card bills before the due date. Defaulting on the credit card will incur a higher interest rate, finance charges, and late payment fees. It will increase your financial burden and negatively impact your creditworthiness as a borrower. 

 

Be wise about your financial decisions, and ideally, borrow as much as you can repay. Paying loans through credit cards should be reserved for emergencies as it becomes easy to fall into a deb-trap.

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Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.

Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.