While credit cards are a convenience to own, you must steer clear of the potential debt trap they may lead you to.
Credit cards can be quite handy if you learn how to handle ‘free money’. However, it can be detrimental if you misuse the card or lack sufficient knowledge about its usage. If you are looking to apply for a credit card, reflect on the pros and cons so that you are well informed about your decision.
Here is a list of the pros and cons that will help you get absolute clarity on the positive features and the pitfalls that you can steer clear of, for a smooth experience.
Pros of Using a Credit Card
Build Credit History
Good credit history is to a bank what a good resume is to a company. Good credit history is built as a result of timely payments of your credit card bills, keeping your credit card balance low, among many other factors1. In simple words, this communicates a sense of trust to the banks. This positive information allows you to qualify for car loans, house loans, and business loans with low interests on repayment.
A credit card allows you to borrow money from the card issuer and repay that amount later with interest. Although, there is an interest-free period, this period varies from bank-to-bank. For example, HDFC credit cards have an interest-free period ranging from 20-50 days2. Thus, if you are someone who can repay the amount borrowed within this period, then you can benefit from a credit advance and enjoy a stress-free financial life.
Repay Borrowed Money in Instalments
There are cases when you may find it difficult to pay your credit issuer in full. While it is best to repay all due amount in full each month, you can still choose to pay your dues over a period of time. The lowest amount you can pay each month is the minimum payment value. This is stated by your credit issuer.
Earn Rewards and Benefits
You can get discounts, earn reward points and cashbacks for spends made using your credit card. To make maximum use of the benefits provided by a credit card, you must choose a card that would work best with your lifestyle. For example, if you are a frequent shopper, then a cashback or store credit card might be the right fit for you. If you’re a frequent flyer, you might prefer an airline credit card that can give you lounge access, discounts on flight tickets, or even upgrades.
Provides Emergency Funding
When you need money in a pinch, credit cards can be considered a backup option. While it is not the best option, it certainly helps you cover an unexpected expense if you can’t afford to pay it from your savings.
A credit card is known for its ability to make a large purchase in equated monthly instalments (EMIs) to avoid denting the bank balance. Most EMIs that are provided for a short-period may come without any interest. A short-tenure EMI generally comes without any interest for select products by some credit issuers. This makes it extremely convenient to make purchases over a tenure without losing any money on interest.
Credit cards offer additional protection in the form of insurance for fraudulent card purchases. In the unfortunate event that your credit card is lost or stolen, you are not liable for any unauthorised charges. However, make sure that you promptly report suspected fraudulent activity.
Cons of Using a Credit Card
Damages Credit History When Misused
Using a credit card to impact your credit history can be considered a double-edged sword. While a high credit score has numerous benefits, a low credit score can give you a bad image. If you run up big balances and pay your credit card late, your credit score is going to plummet, making it difficult for you to qualify for loans in the future.
Tempts You to Spend More than You Can Afford
Credit cards tend to make you feel richer than you are. Many fall into debt as they spend more money than they actually earn. When you spend beyond your purchasing power, you fall into an increasing debt trap.
Minimum Payment Trap
Since credit card issuers know that an impulsive spender would find it difficult to repay in full, they allow you to repay a minimum amount known as the minimum payment. Suddenly, money is no longer a problem and everything seems affordable. This is often considered a trap as the outstanding credit is now carried to the next month with interest, causing a snowball effect on your debt.
Hidden Fees and Charges
The fees associated with your credit card might be a costly nuisance if you are not aware of them. This knowledge can lower your chances of incurring such charges and also help you understand your credit report better. Some of the fees and charges that you can expect for your credit cards include a joining fee, annual fee, late repayment fee, renewal fee or processing fee/.
Credit Card Fraud
Although it is not very common, there are chances you might fall prey to a credit card fraud. These cards not only occur when you lose your card, but sometimes thieves use your credit card information to make purchases. It is important that you check your statements carefully for purchases that might look suspicious. If pointed out in time, banks usually waive off charges once the fraud is proven, so you will not have to pay for those purchases.
Interest rates after the interest-free period are generally very high with the average rate being 3.2% (average interest rate of top 5 banks in India) per month. This would amount to 36% per annum which is a lot of money lost in interest. So, if you are not in a habit of paying in full every month, you should be prepared to pay high interest as a consequence.
Overuse of Credit Card
While credit cards are extremely convenient to use, they might not be the best mode of payment for all your purchases. For example, there are some instances like a college loan where using a personal loan would be a better option owing to lower interests. Similarly, since credit cards incur a cash advance fee at ATMs, the use of debit cards would be preferred.
While Credit Cards may seem to have a downside, they often do more good than harm. If you use your credit responsibly, you can pay a lower amount for your loans, get rewarded, and be financially stress-free. For your next read, learn more about the best practices to make the most of your credit card.