You Cannot Use Credit Cards to Make Insurance Loan Repayments

irda logoHuman ingenuity knows no bounds. And if allowed to operate freely, many of us would behave irresponsibly and misuse/abuse the system to get undue advantage.

Let us consider a hypothetical situation. We know credit cards allow an interest-free credit period. You have a credit card from Bank A. Let’s call this credit card A. You spent Rs 10,000 on this credit card. You get an interest-free credit period of let’s say 30 days.

After 45 days, you use another credit card (let’s call it credit card B) to pay off the bill of credit card A. So, you don’t really pay Rs 10,000 from your pocket but from another credit card (credit card B). This gives you another, say, 35 days of interest-free credit card.

Thereafter, when the bill of credit card B becomes due, you use credit card A to pay off the bill of credit card B. You have still not paid anything from your bank account.

You know where this is going. You can use credit cards to get an interest-free loan for a very long period. That’s not how credit cards should be used, right?

Let’s take another example. You expect that the markets are going to rise over the next 15-20 days. However, you don’t really have much money to invest but you have an idle credit card limit of Rs 5 lacs. You use your credit card to purchase mutual funds for Rs 5 lacs or fund your brokerage account with Rs 5 lacs and invest in stock markets. Or use the credit card to buy futures and options. Zero-interest loan to bet on market movements.

Again, this does not seem right and can lead to unnecessary leverage and speculation. If left to our own, many of us will make a mess of these structural issues. That’s why the regulators have regularly stepped into restraining some of these activities.

You cannot use a credit card to:

  1. Pay off the bill of another credit card.
  2. Purchase mutual funds or fund your brokerage account.
  3. Invest in NPS Tier 2 account (since the Tier-2 NPS account is liquid, it can also be used for speculation). Investment in NPS Tier-1 account is permitted albeit with a small transaction charge.

Note that you can still fund your Paytm wallet with a credit card and use the wallet to settle your credit card bill. However, the wallet will charge you a transaction fee which effectively makes it a NON-ZERO cost transaction.

Similarly, you can use a credit card to withdraw cash and deposit that cash into your bank account and pay off another credit card bill from the bank account. Again, there is a cost involved here. Withdrawal charges of up to 3.5-4% of withdrawal amount. No interest free credit period for credit card cash withdrawals. Withdrawing cash from credit card is an unequivocally bad idea.

Loans against Insurance Plans

Do you know you can take loan against your insurance plans too? Since such a loan is a secured one, you can expect the cost to be lower than a personal loan too.

You can take a loan only against a traditional life insurance plan. Up to 90% of the prevailing surrender value.

You will not get a loan against a term loan or a Unit-linked insurance plan. Not permitted under insurance regulation. Why? For term plans, there is no investment value. What would the loan be secured against?

With ULIPs, there is an investment or fund value. However, this value is not guaranteed and is linked to market performance. Hence, the regulator does not permit loans against such plans.

An advantage of loan against your insurance plan is that you get immense flexibility in loan repayment. The repayment does not have to follow an EMI based-repayment structure. You can keep paying only the interest at regular intervals. And can pay the principal any time before the policy maturity. If the principal is not repaid on time, the insurer can recover the loan dues from maturity proceeds.

Hence, while I am not very fond of traditional life insurance plans, if you have invested in one and need a loan, this could be an option worth exploring.

Why are we discussing these 2 widely different topics (limitations on usage of credit card AND loans against insurance policies) in this post?

Because IRDA, the insurance regulator, has come out with a circular dated May 4, 2023, that prohibits repayment of loans against insurance policies using credit cards. While there is no reason cited, this is a prudent measure.

There is merit in disallowing loan repayments using credit cards. Zero-interest loan for making loan repayments. And the issue is ethical or moral only for those who have funds in the bank account but use credit cards for convenience and rewards points.

For those who use a credit card because they simply don’t have resources to pay off the upcoming loan repayment, this could lead to serious issues. While the credit cards offer interest-free credit period, if you are unable to settle card bill on time, a credit card loan is the most expensive loan in the formal finance sector. Your debt troubles can only worsen if you use credit cards extensively.

So, good job IRDA.

What do you think? Should you be allowed to use credit cards to pay off other loans or bills from other credit cards?

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