Before we get to today's story, a quick recap on all the things we covered this week. On Monday we talked about new regulations surrounding Algo Trading, next we discussed why banks are partnering with non banks. On Wednesday we talked about the dawn of the private space station, then we discusses marriage and blockhain and finally there was the story on Apple's new gambit on AR/VR Glasses.
Also, on the Markets edition this week, we have a great story on Minda Industries and the extraordinary rally we've seen so far.
And with that introduction out of the way, let's get to today's story, shall we?
Last week, we gave you a personal example of how a credit card can be used for budgeting. And while a lot of you wrote back to us explaining how you use similar templates, there were also those who were sceptical of using credit cards for budgeting. And rightly so, this isn’t for everyone and it’s imperative you know there are some risks involved. So in today’s episode, we will talk about those risks and more.
1) If you’re new to credit cards
Walking around with a credit card in your wallet can suddenly make you feel all grown up. It’s a way of telling the world that you’ve arrived as an adult. But if you’re a first-time credit card user, the allure of “free money” can be a heady trap. Swiping your card and seeing the bank balance unchanged can lead to spending more than you can actually afford. And that often happens when you’re trying to portray a lifestyle to impress people. So before you decide to try budgeting using a credit card, give yourself some time. Analyse your spending patterns and whether you can handle the responsibilities of credit. Only then should you consider credit. And if you tack on multiple credit cards, tracking all that split expenses will drown you in a whole host of problems. So please start slow.
2) There’s a real risk of getting into a debt trap
A credit card is nothing but a loan. And banks usually make money when they tack on penalties and additional interest the moment you delay payment. And once you fall behind on your payments, it’s very easy to end up in a vicious cycle of debt. Let’s say you swipe your credit card on the 16th of January. And your billing cycle is on the 15th of every month. So, the bank sends you the statement on the 15th of February. And you usually have another couple of weeks before the payment becomes due. In effect, you’re getting an interest-free loan for 45 days.
When you log in to your bank’s portal to make the payments, you see that there’s something called the ‘minimum amount due’ or MAD. Usually, that’s what is highlighted as the first option in many cases. The amount seems reasonable because it’s usually like 5% of the money you actually owe. So you pay just that and feel happy.
But…what happens to the rest of the money you owe the bank? Well, you’re going to be charged interest on that amount. And that’s usually at a whopping 30–40% rate of interest per year! Also, you lose your interest-free credit privileges and every purchase you make from then on starts attracting a charge.
So if you keep paying only the MAD, well, the amount you owe the bank will shoot up significantly.
The acronym — MAD — seems quite apt now, doesn’t it?
3) It can make or break your credit score
Credit cards are often the stepping stone to creating a good credit history. But it can work pretty much in reverse as well. Each credit card owner is given a certain limit and you can borrow as much. However, if your limit is set at Rs 1 lakh and you’re constantly maxing it out, it will set a bad impression with the credit scoring companies. And if you miss payments accidentally, that can have another adverse impact on your credit score. Meaning when it’s time for you to apply for an education loan or a home loan, the bank will not look at you too kindly.
4) Credit cards and ATMs are a definite no!
What if you decide to ditch your debit card and walk around with only a credit card? If you have an emergency, sure, swiping your credit card is usually fine, so long as you know you can pay on time. But what if you need hard cash? You could go to an ATM to withdraw money using a credit card, no? Don’t do it! Because withdrawing cash on credit cards can be a very expensive affair. There’s a “cash advance fee” of 2.5–3% on the value every time you withdraw cash. But more importantly, you have to remember that you don’t get an interest-free period. That’s right. The moment you withdraw cash using your credit card, you are charged an annual interest rate that’s typically over 30%. Crazy!
So there you have it, just a few pointers to keep in mind whether you’re using a credit card for budgeting or you’re just using one to feel more like an adult. Since it’s the season for Spiderman, remember, “with great power comes great responsibility.”
Until next time...