Why Credit Cards are your best friends!
The only financial advice my Dad gave me before I started my career was to avoid credit cards.
This advice is in line with the view most people have about credit cards, they are a debt trap.
Before we debate that statement, let's get some basic things out of the way:
1. Credit Cards have a monthly repayment cycle. That is, you'll be billed the same day of every month:
Let's say I have a credit card where the bill is generated on the 20th of every month. Then, the bill generated on 20th November will include all the spends from the 20th of October to the 19th of November.
Credit card bills are usually due 15-20 days after bill generation. So, in this case, I would have time until the 9th of next month to pay my bill. This is good because I can wait until my salary is credited to pay my bill.
2. Credit card statements have two amounts:
Total Due: This is the total spends you have made on the card in the past month.
Minimum Due: This is the minimum amount you have to pay to be not considered a bad customer. This is usually much lower than the total due.
So why 2 different amounts on the same bill? Say Hello to the largest source of income for credit card companies.
Whenever you use your credit card, the card company pays on your behalf. At the end of the month, the card company asks you to pay them back. If you don't pay the total amount that is due, then they charge interest on the amount you didn't pay them.
If you pay back only the minimum amount due, you'll have to pay interest on the remaining 30,000.
So, what is the interest rate here?
Somewhere between 3-4% per month. That sounds less, right? Nope. Over a year, that amount comes over Rs. 45,000 (annual interest rate of more than 50%)
This amount then comes to your next month's statement which is in addition to the spends you've made the next month. This keeps accumulating interest (at 50%) until you pay the total due. Debt Trap.
So far it looks like my Dad is right.
Not so fast.
If used properly, credit cards are actually awesome. How so?
They help improve your credit score. If you repay your credit card bills on time every month, your credit score improves with it.
They offer reward points. Different cards offer different rewards for making purchases using the card. You're basically getting money for spending money! How cool is that?
And finally the most important thing, which a lot of people don’t know about. Credit cards offer something called Buyer Protection, which means that your purchase is protected against fraud. Say you ordered something from a shady website, and you didn't receive the product. All you have to do is file a dispute and you'll not be charged for the purchase. This is something that debit cards don't offer. If you use a debit card, the money is never coming back to your account.
It is inherently risky to use a debit card for a purchase.
So credit cards offer you protection against fraud and gives you rewards for spending.
Can they put you in a debt trap? Yes, it can. But that happens only when you spend irresponsibly.
In the immortal words of Stan Lee:
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More power to you.