Getting a Credit Card is not that difficult now-a-days. But how to use Credit Card wisely is extremely important to know.
Credit Card gives you the luxury of having cash available to you anytime. This luxury can ruin your finances if you don’t use your Credit Card fairly. You can easily get trapped in Credit Card debt very badly even before you realize it.
We will discuss here how we can use Credit Card wisely. This helps us in avoiding Credit Card debts and building good credit score.
Before we dig deep into the functioning of a Credit Card, let’s know about the basics of a Credit Card.
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What is a Credit Card?
A Credit Card is a plastic card used to make the payments at merchant sites. Credit Card is issued by the lender or a bank to the eligible customers.
As the name indicates, Credit Card offers credit or loan to the card holder. The beauty of a Credit Card is that credit offered here is totally free of any interest rate or other charges.
Important thing to remember is that this credit is free only in two conditions :-
1. If the Credit Card is used only for shopping and at merchant sites. This does not include cash withdrawals.
2. If you payback the entire amount spent to the lender by the payment due date.
If you don’t pay the due amount by due date, then you have to face the penalty and interest charges.
If you use your Credit Card to withdraw cash from the ATM machine, then this credit amount is not free.There is a one time fee for the withdrawal transaction and much higher interest charges on the amount withdrawn.
How does a Credit Card work?
After you are issued a Credit Card, a billing cycle is assigned to your Credit Card account. This is like a revolving account. A credit amount limit is fixed up to which you can use your Credit Card for spending. This is called the Credit Limit of your Credit Card.
A particular date is assigned to the Credit Card account, on which all the expenses we made on a credit card are added up. A bill for Credit Card is generated on this date which is called as Credit Card statement. Amount billed in the Credit Card statement is called as the Total Amount Due.
After statement generation, around 15 day period is given to pay the bill amount to the lender or the Credit Card issuer bank. The date by which you have to pay the bill amount is called as the Payment Due Date.
Not making payment before the Due Date attracts penalty as well as interest charges.
You have two options to make payment. Either you can pay the entire due amount by the payment due date. If you pay entire amount, then there are no interest levied to you.
Alternatively, the card issuing bank gives you the liberty of paying 5% amount of the total amount due. This amount is called as Minimum Amount Due. This is the amount you must pay by due date.
Paying Minimum Amount Due on or before the Due date does not attract any penalty. You need to pay interest charges only. Interest rate charges are levied on the outstanding amount only, the amount left after paying the Minimum Amount Due.
Interest rate charges levied by the Credit Card companies or banks are very high as compared to the routine interest charges you need to pay for a personal loan.
Credit Card Interest Rates
Credit Card interest rates of nearly 1.5% per month are imposed by the credit card companies on the outstanding or balance amount. It comes out be around 36% per year as compared to a personal loan which you may get for around 9% per year.
Let us understand the Credit Card functioning with an example. I hold an ICICI Bank Credit Card.
The Credit Limit for it is fixed at ₹ 1,70,000. This means I can make maximum spending of that much amount on my card. Credit Card Statement is generated on date of 28th of every month. Payment Due Date is fixed at a date of 15th or 16th of next month depending upon if the month gone by was of 31 or 30 days respectively.
Now to avoid any kind of charges, I need to pay the Total Amount Due on or before Payment Due Date. Then the credit amount I used for my expenses will be totally free.
So, I get interest free credit for maximum of 45 days if I had made spending on date 29th. It is 30 days of monthly cycle and 15 days I get to make payment by Payment Due Date. If I make spending on 27th of a month, then I get 18 days of interest free credit because bill or statement will be generated the very next day i.e. On 28th.
Now coming back to the payment to be made, I can also opt for paying a part of the Total Amount Due which is is the Minimum Amount Due. This is the 5% of Total Amount Due.
Paying Minimum Amount Due ensures that you didn’t get penalize but only need to pay the interest charges on the outstanding bill amount.
The outstanding amount is subtracted from the credit limit. So your credit limit is reduced till you clear all the dues.
How to use Credit Card wisely?
Having a Credit Card gives you so much cash freedom or leverage. It is very useful in emergencies when you are short of cash. You do not have to wait to buy something till you have required money if you hold a Credit Card.
But it is very important to use Credit Card wisely. Otherwise, it can make your life miserable if you get stuck in Credit Card debt.
(I) Always Pay Total Amount Due
First and foremost important thing is that you pay the Total Amount Due by the Due Date. Don’t get carried away by the luxury of paying Minimum Amount Due. Why to pay unnecessary interest charges if you can make full payment?
You should be aware that paying Total Amount Due by Payment Due Date keeps all your spending transactions interest free. If you opt for Minimum Amount Due, the outstanding amount, of course, is charged but even the future spending transaction you make also start attracting interest charges from that very day you made it. Now they are no longer interest free.
So, the outstanding amount starts piling up on due to high rates of interest. Over the time it becomes very difficult to clear those balance amounts.
(II) Invest your Liquid Cash to Make it Grow
You can keep using your Credit Card for your daily routine expenses. Leave the liquid cash you have in your savings bank account to grow.
The banks give interest rates of about 3% on the idle cash you hold in your savings account. Alternatively you can opt for short-term fixed deposits or Liquid Mutual Funds to get higher returns.
When the Payment Due Date nears, dissolve the fixed deposits or the liquid funds and make full payment for Credit Card bill.
(III) Be Vigilant to Your Expenses
Always keep an eye on your spending through Credit Card. By making payments through a card, you don’t feel the pain of money slipping out of your hands which we normally do while making cash payments. This may lead to overspending and big Credit Card bills.
(IV) Never use Credit Card for Cash Withdrawal
Never use your Credit Card to withdraw cash at the ATM machines except in dire emergency. If you have to, pay back as soon as possible.
(V) Split Big Transactions into Smaller
If you have made a big amount transaction on your Credit Card and it is not possible to payback full amount, get it converted to equated monthly installments (EMIs). Doing so attracts lower interest rates of around 12% as compared to normal rates of around 36% per year.
Hence,there are several ways to use your credit card wisely. Taking care of them, credit cards can be very advantageous to you finance.
So, if you use credit card wisely, it can be very useful for your savings account. Just use Credit Card issuer’s money to meet your expenses and make your money to grow every month.
Another big advantage you get is a good Credit Score. However,following the above rules for wise use of credit cards for excellent credit score is must.
Having a good credit score makes you eligible to get loans from the financial institutions. Lending companies always look at your credit score before issuing loans.