Credit cards and its wise usage

K. Davidraja Faculty of Commerce and Management Eastern University

A credit card is part of a system of payments named after the small plastic card issued to users of the system. It is a card entitling its holder to buy goods and services based on the holder’s promise to pay for these goods and services.

The issuer of the card grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user.

The Proper use of Credit Cards

Credit cards are a convenience, not a crutch. Credit cards are a great way to make purchases and record to the penny you’re spending. They also provide a way to postpone payment on items and thereby earn more interest on your money. For example, if you have a money market account that gives you 5% annual interest and you spend 1500 a month through your credit card, you can keep that 1500 in your money market account for an additional month.

At the end of a year you would have earned an additional 51.16 for doing nothing. Now 5100 may not be much but it’s free! Also you can use your credit card statements to keep track of exactly how much you are spending and where your money goes.

With some credit cards you can use personal finance software to download your credit card transactions from the Internet right to your home computer.

Credit cards may actually save you money. Some people avoid making purchases if they do not have cash. Cash seems to “burn a hole” in our pockets, it just disappears. It is so easy to spend and it is right there. But a credit card takes more effort and you know that you have to pay the bill later that month.

Your credit card may also offer a rewards program where you get cash back, frequent flyer miles or discounts on services and merchandise.

Credit cards are convenient. Some purchases, especially those on the Internet, will only accept credit card payment. Also you don’t have to continually go to the bank or ATM to get cash. A credit card also provides a measure of safety. You don’t have to carry large amounts of cash for large purchases.

Even if your card or credit card number is stolen, you are not responsible for the thief’s use of your card.

But credit cards can also be a crutch. Too many people see their credit limit not as the maximum amount of debt they can go into, but as an account full of money that they can spend. Average household consumer credit balances have now topped Rs. 70000.

The monthly interest charge for a credit card charging 18% interest is over 10,000. More than 1,20,000 a year just in interest. And this interest is not like home mortgage interest that you can deduct from your taxes. You are paying an additional 15-36% on top of the 12000 for taxes on the interest you are charged.

That brings your interest charge total up to 14,000-16,000 each year. Even more if your balance or interest rate is higher.

What is silly is that many people who are paying 18% interest rates on credit are also investing in a stock market that only averages 11%. Or worse, keeping money in money market, savings accounts or CDs that only pay .5-3%. Want an investment that returns over 20% Invest in paying down your debts.

In the above example you can save over 20% with taxes factored in many people have developed the habit of using their credit cards to buy what they want now and paying for it later.

They then make only the minimum payments required. Often the minimum payment is set so that you only pay the monthly finance charge (interest) or just a small amount above it.

This will keep people paying that 18% rate for years. A 10,000 purchase can end up costing 15,000 when paid off after five years. Ironically many of these same people will wait months for a sale so that the item’s price goes down 10-20% and then make a purchase on their credit card and end up giving the savings to the credit card company instead.

Sometimes the credit card can lead a person into living a lifestyle that is beyond their means. If a person gets in the habit of dining out two to three times a week and these meals are paid for by credit card, the card balance increases quickly.

Often the additional expense was not planned or budgeted. People can even end up spending more each month than the actually earn.

This can continue as long as the credit card balance is below the limit and the person makes their regular monthly payments. But as soon as the credit limit is reached, many credit companies will increase the credit limit and give the person more room to get into debt.

I have personally seen a credit card limit expanded by Rs. 100,000 within three months. This cycle can continue until the person is required to make a minimum payment that is more than they can afford.

Now not only do they have to cut back on the lifestyle they have grown accustomed to over the years, but they also have to either increase their income or cut out things they enjoyed before increasing their lifestyle with their credit card.

Also what happens if the person is suddenly out of work or has to take a pay cut or lower paying job. That’s right, the credit card bills keep coming. And many people rely on the remainder of their credit limit to supplement their income until they are working again or can find a better paying job.

We have seen this cycle in America increase average credit card balances each year and eat up the equity in many people’s homes. Home equity loans are used as credit cards to live a lifestyle that is beyond people’s means. Or to purchase toys they really can’t afford to buy let alone keep and use.

Or the home equity money is used to “pay off high interest credit card debt” as the ads suggest. But then people continue the habit of living off their credit cards and get right back into debt again.

Important: pay off your credit card balance each month. Don’t buy something now and expect the big end of year bonus to pay off your credit card. Even if you do get it, you will probably spend it on something else.

Don’t fall into the habit of living off your credit cards. If you have Rs. 10,000 of disposable income to spend each month, whether through a credit card or in cash, only spend the Rs. 10,000. Don’t try to make up for extra expense this month by assuming you can catch up on your credit card payment next month.

It won’t happen. If you have developed bad credit habits, cut up your credit cards, or only keep one for emergencies and resolve to pay off the balance each month. Then create a plan to get yourself out of debt and stick to it.

You can relieve stress, avoid family conflicts and sleep better at night knowing that there are no credit card wolves howling at your door.

Use your credit cards wisely

For many people, managing a credit card is harder than getting one.

* Understand that any time you use a credit card, you are borrowing money. If you don’t pay off your balance each month, interest will be added to the total amount you owe.

* Think before getting your first credit card. Think very carefully before you decide to get your first credit card. Do you really need a credit card or would another option work just as well? Some other options to think about:

* Getting a debit card, which is connected to your checking or savings account rather than borrowing money for each transaction.

* Considering sharing a card with your parents and asking them to help you stay on track.

* Waiting. Just put off the decision for six months or a year and see how well you might do without a credit card.

* Choose wisely. When selecting a credit card, you should shop around for the best deal. Compare different cards based on your own situation. Look for the following:

* A low annual percentage rate (APR). The lower the rate, the less interest you have to pay. Watch out for low introductory rates that are raised after a year or less.

* The interest calculation method. This affects how much interest you pay, even when the APR is identical.

* Low or no annual fees. If the issuer charges an annual fee, ask them to waive it.

* All other charges (i.e., late payment fees, transaction fees, over the limit fees, etc). These can really add to the total cost of your charges.

* A grace period. Some credit cards charge interest from the day that the charges appear on your account. Other cards offer a grace period for you to pay off your balance before interest charges begin to accrue.

* The credit limit. Keep your credit limit low (think about $500 or less), to make sure you don’t get in over your head.

* Wide acceptance. A major credit card is convenient, and easier to manage.

* Services and features, such as cash rebates, frequent flyer miles, extended warrantees, etc. Think carefully about the true cost of these programs when you consider interest and other charges.

* Limit the number of cards you get. It will be easier to keep track of your spending.

* Track your spending. Waiting until your statement arrives once a month to think about your balance can get you into trouble quickly.

* Check your account online frequently.

* Save receipts.

* Maintain a ledger.

* Consider signing up for balance notices and billing statement notifications from your credit card provider.

* For each of your cards, keep a record of the following in case your card is lost or stolen. Even better, keep a photo copy of the front and back of your card in a safe place at home.

* Account number

* Issuer’s name

*Phone number

How to use a credit card

Steps

1. Decide whether you can afford the purchase and know how you are going to pay the credit card bill once it comes.

2. Be sure your card is signed on the back by you.

3. Slide your credit card through the machine. If the machine asks you for your P.I.N. number, press the cancel key. If the machine asks if you want a credit transaction, press the credit or yes key.

4. Sign. If the machine is an electronic machine, sign in the box. Press the OK or accept key.

If the machine is not an electronic machine, circle the amount on the receipt (this forces you to see it and hopefully recognize errors) sign on the line on the receipt. Give the receipt to the cashier.

5. Present your card to the cashier if asked to do so. The cashier would check off the signature on the card with the one you just signed on the receipt.

6. At the end, you should get back your card.

How to use a credit card to save money

Steps

1. Get on the Internet and check out credit card Web sites such as CardWeb.com or Bankrate.com, where you’ll find information about credit cards and rates.

2. Evaluate each card that offers an interest rate you can accept, as well as perks you want.

3. Know that the deals may change weekly or even daily. If you see a deal you can’t pass up, apply immediately.

4. Hunt for a card that offers travel benefits such as frequent flier miles or discounts on travel services.

5. Check out cards that offer free insurance benefits. Some provide Rs. 10,000 or more of accidental death and dismemberment insurance. Others offer coverage of rental car accidents and lost luggage.

6. Evaluate cards offered by Internet service providers. Some will pay your monthly ISP subscription charges if you make big purchases on the card.

7. Look for cards that offer bonus points. The points can be exchanged for discounts or freebies at restaurants, department stores and bookstores.

The bottom line: Don’t spend more than you can afford to pay on a monthly basis.

Wise use of your credit cards will help you establish a solid credit rating and avoid financial problems.