Top Credit Card Mistakes to Avoid

Credit cards are easily available these days. The banks keep chasing customers with attractive offers (or so they say) on their credit cards. Personally, I am not against credit cards. If you use your credit cards judiciously, you can save a lot of money. You get an interest free credit period of up to 52 days. You can get discounts at restaurants, hotels, flight booking and various online shopping portals. Then, there are rewards points which can be redeemed for exciting gifts. Moreover, it can also help you build credit history.

On the flip side, if you are reckless, it won’t take long before you get into a debt spiral. Here are some of the common credit card mistakes you must avoid.

1. Spending More Than You Can Afford

A credit card gives you the power to spend the money you do not own. This false sense of power can sometimes lead you into a debt trap. You may end up spending more than you can afford.

If you use a debit card for purchases, you get a message from the bank telling you about the balance in your savings account. This helps keep a check on your spending. With credit cards, all you get is the transaction amount. Banks never send messages to tell you the outstanding amount of on your credit card after a particular purchase. Hence, it is easier to lose track of your expenses with credit cards.

2. Skipping Credit Card Payments

You must always pay credit card bills on time. The interest on credit card debt can run up to 3% per month, effectively more than 40% per annum.  And I have not even considered different kinds of penalties (with different names) and the impact of service tax. Defaulting on your credit card payments is certainly not a wise thing to do.

Not only do you invite late payment fee in your next credit card statement, a credit card default can also impact your credit history adversely. With a low credit (CIBIL) score, you will find it difficult to get loans from banks in the future.

It is one thing if you do not have enough money to settle credit card bills on time since you do not have enough money to pay the bill.  Forgetting to pay credit card bill on time is outright stupid.

3. Paying Minimum Amount Due

By paying minimum amount due (MAD), you avoid paying any late payment fee and adverse reporting to credit bureaus. This step is certainly better than skipping the payment altogether. However, this is not something you should target. Though you can keep your credit card account regular by paying only the MAD, you still pay the heavy interest on the outstanding amount. Additionally, you lose the interest free credit period. You will be charged high credit card interest from the date of your purchase.

4. Not Understanding the Charge Structure Properly

Most are aware about the high rate of interest charged on outstanding credit card debt but they ignore multitude of other charges that are levied by credit card issuing banks. If you think you are paying only 3% per month on the outstanding amount, you are wrong. You have to pay late payment fee, finance charges and service tax too.

Consider this: You missed a payment of Rs 2,000 on credit card. You have to pay Rs 600 late payment and Rs 200 of finance charges along with interest. Add service tax to it. You will have to pay almost Rs 1,000 extra. And you were thinking you need to pay only 3% per month.

5. Paying Excessive Importance to Reward Points

Credit card issuing banks regularly tempt customers to reward point offers. “Get 5X reward points on a particular website if you make a purchase before 30th of the month”.  It is acceptable if you were already planning a purchase and used this offer to your advantage.

However, making a purchase simply because of this offer makes little sense.

Every credit card has a different rewards scheme. Let’s consider a credit card where you get 1 reward point for every Rs 100 of spending on the card. On a spending of Rs 10,000, you will get 100 reward points. Under the rewards point offer, you will get 500 reward points on the same purchase.

By the way, a reward point is not equal to 1 rupee.  Typically, value of a reward point varies from 20 paise to 40 paise.  And that’s quite intentional. The bank could have made 1 reward point equivalent to 1 rupee. However, 0.4 reward points per Rs 100 of purchase does not sound that tempting. Plus, banks can simply reduce the ratio to save costs.

500 reward points are equivalent to Rs 150 (at 30 paise per reward point). Not very significant. You could have saved this money shopping for discounts in a few stores or online portals.

Moreover, most credit card companies do not allow you to set off rewards points against your bill outstanding. You have to buy something from their rewards collection. You may not even find anything useful in that collection.

6. Focusing on the Absolute Amount and Not the Rate of Interest

You spent Rs 40,000 on your credit card on the last day of your statement cycle. You did not make the payment.  The bank charged you Rs 1,200 of penal interest (from date of purchase) in the next statement. Additionally, it charged you late payment fee of Rs 600 and some finance charge of Rs 200. That makes it Rs 2,000. Add 15% of service tax and cess to it. The amount becomes Rs 2,300.

From what I have observed, many borrowers tend to assess impact only in absolute cost. “I spent Rs 40,000. Even if I don’t pay for 30 days, I have to pay only Rs 2,300 extra. That’s ok.” This is not the right approach.  You can see fixation with the absolute cost.  You are paying almost 6% per month on the outstanding amount.

7. Hiding Your Credit Card Woes from Friends and Family

This applies to most problems in life. If you share your problems with family or a trusted friend, they might come up with a good suggestion.

In case of financial stress, they might even help you with money. Advice is alright but loans from friends and family should be taken with caution. Inability to repay friends/family on time may even jeopardise your relationship.

8. Not Exploring Other Options

Credit card debt is the most expensive debt in the formal finance sector.  Therefore, you must always try to pay your credit card bills on time. However, there may be scenarios where you have run up significant credit card debt, cannot muster enough money to repay bills on time and foresee this problem to continue for a few months. In such cases, you must explore options of balance transfer or converting purchases into EMI. These measures can offer you short term relief.

Alternatively, you can take a personal loan to repay credit card debt. Personal loans are expensive too at 14-18% per annum. However, a personal loan is still much cheaper than credit card debt.

9. Withdrawing Cash Using Your Credit Cards

A credit card is not a debit card. If you use your credit card to withdraw cash from an ATM machine, you are charged interest from the date of withdrawal. There is no interest free credit period when it comes to cash withdrawals using credit cards. Apart from the interest, the bank typically charges a certain percentage of withdrawal amount as fee. Avoid this unless absolutely required.

10. Misunderstanding Introductory Offers

Under introductory offers, you might get a credit card without any joining fee. First year renewal fee may be waived off. However, the card may not be free for lifetime. You may have to pay fee from the second year. Alternatively, the waiver of renewal fee may be conditional. You may have to spend minimum amount during the year before the renewal fee is waived off.

The sales teams of banks conveniently choose to hide such details from customers.  You might be in for an unpleasant shock when you see renewal fee in your credit card statement. Do understand the terms and conditions of the card before signing up for the card or when you receive the terms and conditions along with the credit card.

Further Reading: Avoid These Common Credit Card Mistakes

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