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Credit cards are like jazz: Some love it with all their heart while some others hate it as fervently. Depending on who you ask, credit cards are a boon or a massive sinkhole which takes away all their money. If you look closely, it all depends on how you use a credit card that decides how you will perceive it. If you use it wisely, it can actually help you save money but if you are reckless, it can punish you. Hence, it is important to understand how to use a credit card wisely. But first...
Why even use a credit card?
Credit cards are an important financial tool that work on 'credit' which is basically a loan. The bank that issues you a credit card is giving you a loan within a maximum limit (your credit limit) and a credit period. During the credit period, you are charged no interest. But if you pay after the due date, you must pay hefty interest fees and late fees on the principal amount.
Credit cards come with a host of benefits which are the most important reasons to use them in the first place:
1. Credit limit and Interest free credit period:
This is the most basic feature of credit cards. Say, you have a card with a monthly limit of one lakh and a credit period of 45 days. This means every month, you can use your credit card to spend one lakh and you don't have to repay that money until the due date. Credit cards give you the opportunity to use money that you don't actually have at the moment while giving you a breathing time to repay it. Also, in the interest free period, they don't charge you any interest, unlike other forms of loans. In that sense, credit cards help you spend before you actually have the money. This is its biggest advantage and also its biggest con (which we will discuss later).
2. Reward points, discounts and offers
Since credit cards have one of the highest interest rates of any financial instrument, banks desperately wish to rope in more people into their credit card customer base. This often translates to many rewards and offers which are used to entice customers. Most credit cards give you reward points for spending through their credit card. They also partner with shopping apps, travel apps, movie booking apps, restaurants, malls, etc to provide various offers and discounts for their credit card users. Many cards also give free airport lounge access to their users. If used wisely, credit card offers can actually help you save a lot more than you might pay in annual fees.
Pro-tip: Try to get credit cards which provide regular offers and discounts for your existing spending patterns. So if you travel a lot, a credit card with discounts on airplane tickets and lounge access might be the right choice for you. If you order food online regularly, a card partnered with a food delivery app will be good for you.
3. EMIs:
Credit cards also let you make purchases using monthly installments so you can divide your big purchases over several months. Not just that, many credit cards also offer no-cost EMIs where you don't have to pay interest on your monthly installments making your cost of purchase the same while getting the luxury of paying over many months. This makes using credit card EMIs much cheaper than taking out a personal loan for a big purchase.
4. Your credit score:
If you ever plan on taking a big loan in your future, like a home loan or an education loan, having a few credit cards can help you big time. All credit cards you take will be linked to your PAN card or an equivalent in your respective country that ]helps create a record of your credit card usage as well as your repayment history. Based on this usage, you are given a 'credit score' that tells you how good you are at taking and repaying debt. If you have been consistently paying up your dues on time, it builds a beautiful credit line history and increases your credit score which then tells banks that they can trust you with their money, making taking loans easier in the future.
So what's the problem?
Everything sounds wonderful until now. Credit cards sound awesome, don't they? What is there to be worried about? Well, there is. Credit cards have a number of disadvantages, some of which can truly make you financially ill. Let me elaborate.
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1. High interest rates and hidden fees:
Even though credit cards sound amazing, they are actually the most expensive form of loan you can take. Credit cards normally have interest rates as high as 36% which is about 3-4 times as much as a personal or a home loan. So, if you don't actually pay up on time, you may end up paying huge amount on just your interest. If that wasn't enough, credit cards also have a number of hidden fees and charges such as late payment fees, processing fees, as well as joining and renewal fees. All these could end up burning a hole in your pocket.
2. Minimum due:
When you get a credit card bill, it often comes divided into two parts: the minimum amount due and the total amount due. People often think that if they pay the minimum due now, they can pay the rest of the amount later, without paying interest on it. Some may even think that it is all the amount they are actually expected to pay. But it is only the amount you have to pay to continue getting the credit facility. And if you pay only the minimum due, you still have to pay the interest on the rest of the amount, which we already know is too expensive.
3. Overuse:
Since credit cards can allow you to use money without actually having it, it is very very easy to overuse the credit card. People often buy things they don't need and go on shopping splurges because they don't actually have to pay at the time of buying. There's also the really bad idea of paying the dues of one credit card using another card which people with big credit card bills often get and eventually end up regretting big time.
So how to use your credit card smartly?
Now that we know the advantages and disadvantages of credit cards, we can also easily understand how we can use credit cards smartly so as to maximize our benefits while avoiding the traps that come with it.
1. Pay your credit card bill on time:
Look forward to paying your credit card bills, even though it may not feel good. You can wait till the due date so as to get maximum benefit of the no-interest period but I suggest you pay it a few days earlier. If possible, set a date every month to clear all your dues. And pay the full amount, not just the minimum amount. This way, you save yourself from the high interest rates, hidden penalty fees, and build a great credit score.
2. Spend only as much as you can pay:
Since we want to pay our credit card bills on time, it would be in our interest to spend only as much as we are able to pay. Splurging using credit cards because you don't have to pay right away is something broke losers do. If you wish to keep your financial health good, it is best to be sane with your spending, even when you are getting the money on credit. A good rule of thumb is to use upto 50% of your credit limit. If you cross this limit, it is time to analyze your bills and see how much of it was actually necessary spending.
3. Make use of offers and discounts:
One of the best reasons to have credit cards is the offers and discounts that come with it. Always be on the lookout for good cards that have great offers and discounts for things that you regularly spend on. You can have a large number of credit cards too, each offering something from your regular spending avenues, as long as you follow the first two rules religiously.
4. Monitor:
Always keep a tab on your monthly credit card statement, especially if you have more than 1 card. This will not only help you keep a check on possible fraud, but also on your own spending habits. Ensure you don't go overboard in your spending for a miniscule number of reward points. Monitor yourself and save yourself from your crazy version.
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