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The Good, The Bad and The Ugly about using a credit card

Credit card or plastic money as it is popularly called, is a fantastic financial tool which you should for your benefit. Having said that it is important to realize that risk of habitual overspending with credit card is a real threat and can wipe off all the benefits for which credit card is subscribed to in the first place. Brighter side of using a credit card thus not only has a darker side to it but also has shades of grey.

There are many benefits of using a Credit Card. Foremost it scores very high on convenience. For any purchase transaction you do not need to carry cash if you have a working credit card in his wallet. It literally makes your wallet lighter. It helps avoid hassles of providing exact change when you settle the bill at billing counter. You save time in counting cash, especially if it is a big amount. It becomes a face saver when you are staring at cash shortage just because you were not expecting a particular transaction at that time or when value of the transaction has exceeded your expectation. It protects you from the loss of cash due to lost wallet- card can be blocked on click of a button or by a phone call.  It reduces you frequency of visit to bank/ATM for cash withdrawal as total cash requirement shrinks.

Secondly it adds to the Purchasing Power of the user. This is especially true when you are buying some high value item. Just at the click of button or at the swoosh of a swipe you can spend even if you do not immediately have that amount in your bank account or wallet. True empowerment comes when you can give add-on cards to your non-working spouse, dependent children or retired parents for their daily spends. Such empowerment makes the user, or his family feel confident to spend and meet their daily needs. One could effectively deal with situations of sudden spending say due to unexpected breakdown of white goods like AC, Fridge washing machines etc and thus needing immediate replacement.

Thirdly it has the potential to act as a contingency fund for you. Most of the credit cards come with the spending limit (technically called as Credit Limit) of few lakhs depending on type of card and credit history of the user. This credit limit acts as a contingency fund. (A contingency fund is accumulation of some corpus in highly liquid instrument so that it can be withdrawn at short notices for unforeseen emergencies). Most of the credit card companies will give you an option to increase credit limit on temporary basis that too at a short notice to help you tide over immediate crisis.

Fourthly Credit Card comes with interest-free credit period. This period is number of days between date of transaction or billing date and the monthly settlement date. This can be anywhere between 20 to 50 days depending on the date of transaction. This credit period is completely interest free. (provided one does not have any rollover amount in that month). This interest free credit adds to your bottom line. For example if one spends Rs 1,00,000/- per month on an average (which is normal these days for a family of 4 to spend) and gets an average interest free period of 30  days, month on month then he is actually getting interest free 1 Lac for full year. This is a benefit of INR 8000/- every year (at 8% cost of capital).

Fifthly responsible usage of credit card (no roll over of debt, no late fees etc) results in creation of good credit score. A good credit score has benefit that it qualifies you for lesser interest rate of approx. upto 0.5% when you go to a bank for a home loan or an education loan. No usage of credit card means no credit history and banks cannot pass on this concession as they do not know your financial behaviour.

Sixthly spending through credit card ensures traceability of your expenses. Credit card usage thus creates a digital trail which can be used by you to track your spending. It is a great advantage for you if you are struggling to know how and why your cash outflows (spending) are exceeding your cash inflows (incomes)- the mystery gets solved here!!! Traceability leads to self-discovery of your spending habits and opens an opportunity for you to monitor and control expenses if required. Traceability is a good way to prove a financial transaction and prevent or identify a fraud.

Finally, most of the credit card companies offer rewards programs on their cards with the purpose of incentivising the use of their cards. There are variety of rewards program available these days. I will restrict myself to naming few only as discussing all of them is out of scope of this article. The most popular one is credit of reward points with each transaction where these accumulated points can be redeemed by you as cash against future purchases. Then there is cash-back on certain types of transactions, discounts on select brands, waiving off charges for use on petrol pumps, jewellery etc., use of luxury lounges at airports, 5 Star hotels etc. All this add to monetary and non-monetary benefits for you.

Just like two sides of the coin, use of credit cards has a potential bad side to it. Excessive usage by you can lead to behavioural changes for worse in your spending habit as you are now tempted to overspend. Itprovides you a “convenience” of overspending. Living beyond your means on monthly basis can become a nightmare for you. It can encourage you to spend money on products and services which you don’t necessarily need. The glamour of swipe and swoosh gets better of you. This can lead to possibility of uncontrollable and unexpected debt which may be very difficult for you to square off later at the time of monthly settlement.

Usage of credit card can inculcatein you a false sense of being happy owner of money prescribed as credit limit. You may fail to realize that credit card is basically an instrument used by banks to lend and you are basically borrowing money when you use the card. This borrowing though free initially (for interest free period) comes at interest cost, should you decide to pay it in the subsequent month(s). Then there are variety of fees charged by credit card companies which can make hole in your pocket. Annual chargeis a type of fees charged by credit card companies for giving you credit card. There is late fee for delayed payments, cash advance fees for withdrawing cash, balance transfer fees, foreign transaction fees, return payment fees, overlimit fees etc.

One of the pitfalls of using credit card these days is the risk of fraud. Credit cards (and other electronic forms of payment) carry a unique danger of you becoming an easy victim of cybercrime which is on rise. No matter what steps are taken by banks and credit card companies to fight this menace, vulnerability remains for you. Credit cards can be stolen, cloned and thus can be used to steal your money and identity.

There is more downside or and the ugly side to using a credit card. One experiences this when one starts rolling over the debt instead of clearing all the dues on monthly basis on or before the stipulated payment date. Now this can happen due to ignorance or carelessness by you. The possibility of it happening due to your inability to square off this debt on monthly basis is also there. The interest charged on daily balance basis is approximately 3% per month or 36% on annual basis! This makes credit card debt as most expensive debt or highest interest rate across any format of financial instrument. These interest rates vary for different cards but most of the credit cards charge in and around 36% per annum. This is very harmful because you are not able to realize that you are paying such interest rate because it comes in small tranches every month and it is written in very fine print in the terms and conditions of the credit card which you do not read ever.

The other ugly term of the usage of credit card is immediate end to credit free period as soon as you carry over the debt to subsequent month. The whopping interest rate of 36% is now applicable to all fresh transaction done in the subsequent month(s) till the whole outstanding amount due is paid off. This is irrespective of the fact that your new transactions might be paid by you in the same month itself. Let us understand this with example. Rajesh has rolled over his due amount to April by not settling all dues on 31st March which was the date of settlement. He then makes a fresh transaction on 10th April for INR 10,000 which he settles on 30th April along with rolled over debt. He is still subjected to 36% interest rate for 20 days on INR 10,000/- (apart from rolled over amount) though technically he did not exceed the allowed credit period on this specific amount. Are you aware of this?

Not understanding these issues and indiscipline in spending habits can lead to mounting debt for you. Habitually rolling over the amount payable monthly, month on month accompanied by fresh transactions can lead you to a debt trap!! This is because heavy interest charges add to your base amount and further weakens your ability to clear off the debt. You don’t expect credit cards to be gateways to a new debt (you are already burdened with home loans, education loans etc.) but if you do not realize the responsibility which comes with owning a credit card, you are inviting trouble for yourself.

Beware of the potential risk of converting an asset (good side) into a liability(bad and the ugly side) by indiscriminate use!!

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