Spot and side step these credit card traps
Knowing the terms on which a card is issued helps you use it responsibly, and avoid a debt trap
The one thing in your wallet that can cause your money life the most damage is your credit card. For all the convenience that it offers in making payments and managing your cash situation, if not used right, it has the potential to derail your financial situation for a long time. A small lapse in discipline, or an oversight when dealing with your credit card can hit you where it hurts most: your finances. Not only do you pay a steep price for the error, its effects are felt for a long time, whenever you need a loan or credit facility. If you know the pitfalls, then you can avoid them as far as possible.
Does not equal extra cash
Having a credit card does not mean your income has gone up. Limit your spending to what your income can support.
Just because you have an instrument that stands in for cash does not mean that your income itself has gone up. Swiping the card for your purchases without having to fork out cash immediately may give you the feeling that you can spend endlessly. But there is a credit card bill that will come to you at the end of the month which you will have to settle.
The credit card just gives you some more time to pay the bill for your expenses and purchases. Use the card only for those expenses that you can afford to pay off by the due date when you receive the bill. If you spend more than what you can pay when due, you will be charged very high interest rates, not only on your unpaid bills but also on any additional spending you do on the card till your entire outstanding debt is cleared.
“Restrict your spends on the credit card to the extent to which you can service regularly. If you look at the spends via credit cards, people usual swipe on holidays or to buy white goods, which are more aspirational spends. You should never spend beyond your means. If you often find it difficult to manage your credit card bills, it would be better to stick to debit cards,” said Suresh Sadagopan, a Mumbai-based financial planner.
Remember, your credit card is a convenience; not additional income. Limit your expenses to what you can afford.
Don’t stop at minimum amount
Paying the minimum amount due does not mean you are done with your repayment obligations for the month. It is just the tip of the iceberg.
The term is self-explanatory: it is the minimum amount due; not the total amount due. Paying the minimum amount due keeps you from being declared a defaulter by the credit card company. But you will pay a high cost in many other ways. First, you will be charged a high rate of interest on the outstanding balance and all future purchases till you clear all your dues. As long as you have unpaid balance on your account, you will have no free credit period any more where you can use the card and the payment is due only later. Every time you use the card, you will be charged interest immediately. And as long as you don’t pay off your debt in full, you will also be paying interest on the interest.
Remember, making only the minimum payment due is a debt trap. If you spend just 5,000 on your credit card and pay only the minimum amount due each month, it can take over six years to repay the debt (assuming an annual interest charged of 39%).
Withdrawing cash is loan
The cash withdrawal facility is also a loan. It is not your money and it is not free. Don’t confuse the cash you withdraw from your bank account through the automated teller machine (ATM) with the cash withdrawal facility offered by your credit card.
The first is your own money; the second is a loan on which you are charged interest from the day you withdraw. When you use your credit card for paying for purchases and expenses, you become liable to pay interest only if you do not settle the dues on the due date. When you use your credit card to withdraw cash from the ATM, you are charged interest from the day of transaction till you settle your dues. Apart from the interest, there is also a transaction fee which may be as high as 2.5%, that is charged when you withdraw cash.
“Many cardholders don’t know that if you withdraw cash on your credit card you will be charged an interest from day one. People assume that there is a 30-40 day interest-free period. Remember that you don’t get a interest-free period for cash withdrawal like you get for credit card bills,” V.N. Kulkarni, chief counsellor, Abhay Credit Counselling Centre, which is affiliated to state-run Bank of India.
This is an expensive loan. If you withdraw 1,000 from the ATM using your credit card, and repay it after a year, you would have been able to use only 760 after paying interest and transaction fees (assuming a relatively low interest cost and transaction fee of 24% per annum).
Don’t stop using it
Not using your card at all is not a smart move either. Your credit card usage is taken as an indicator of your behaviour as a borrower.
After reading all the potential traps in credit cards, you may decide that the best thing to do is to not use it at all. But that may not be a wise decision after all for the impact it can have on other borrowing transactions you may have.
Lenders, such as banks and housing finance companies look for clues on how responsible you are as a borrower before they sanction a loan and decide on the interest to charge. Along with any other loans you may have, they also look at how you have used your credit card and your repayment behaviour.
In fact, there are agencies that are empowered to collect such information on all borrowers, including credit card users, and make it available to lenders for a fee. Restricting your credit card usage to well within your credit limits, making payments on time, not having to resort to paying only the minimum amount due, are all positive behaviour that may get you lower interest rates, higher loan sanctions and good loan terms in the future. But if you don’t use your credit card at all, then the lenders may not have anything to judge you by, and may assign you higher interest costs and stricter loan terms.
Using your card for essential or regular expenses such as groceries will create a spending and repaying history that is responsible and positive. These are expenses that your income is typically adequate to meet and there is no risk of default or you being unable to meet your card obligations.
“Credit card can act as a tool to track your expenses every month. This way you can get a clear picture of your spends. Also, if you use credit cards prudently, you will be able to enjoy the free-interest period,” said Anil Rego, a Bengaluru-based financial planner.
Remember, the way you use your card can have both negative and positive impact on your financial life. Use your card to establish a trail of good spending and repayment behaviour.
Go through the statement
Ignore your monthly credit card statement at your own risk. There may be errors that need fixing and details that require your attention.
“It is critical that all customers read their credit card monthly statements as it not only provides detailed information of the transactions but also of the total amount due, the minimum amount due and the payment due date. The statement also carries terms and conditions and applicable charges. It also provides the customer with details of offers, discounts or benefits,” said Anil Ramachandran, head-retail unsecured assets credit cards and personal loans, IndusInd Bank Ltd.
The monthly statement also helps you keep an eye on all your spends. “Always check all the transactions that are listed in your credit card bill to see if it is a valid payment. From a safety angle, it is important to check the data. Also, credit cards have different offers such as airline miles or points for spending on fuel. Your bill can give you details on how much you have saved and if need be whether you should switch to another card,” said Adhil Shetty, chief executive officer, Bankbazaar.com.
Read your statement in detail to keep control of your spending habits. Apart from catching errors, seeing the numbers in black and white can act as a wake-up call if you have been spending too much.
Knowing the terms on which credit cards are issued helps you use them responsibly. It is in your interest to do so. It keeps you away from debt, avoidable interest and financing costs, and you are more in control of your finances.
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First Published:4 Jan 2015, 07:18 PM IST
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