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Credit Cards 101
In 2020, my bank approved my request for a credit card. Over the last year and a half, I’ve learned a lot of things about using credit cards, and in this article, I’d like to go through them, hoping it will help someone get their first credit card or some form of line of credit. A couple of items to address before we get started: First, I understand the incredible privilege that I have to be approved for a credit card when there are many people who can’t afford 3 meals a day. Second, the points that I am going to touch upon are sort of exclusive to the country of India, but a few of them are general, so they will apply to any other country too. Cool? Let’s get started.
Wait, why do I even need a credit card?
This is a brilliant question. There are a few facts, and then there are the emotions of people that play into the entire picture of debt. Let’s go over the facts first:
- A credit card helps you build your credit score. A good credit score will help you get a low-interest rate mortgage, car loan, personal loan, etc. in the future.
- A credit card helps you keep track of all your spending using new-age apps such as CRED or even the mobile banking apps of large banks.
- Credit cards let you keep your actual cash in your savings account for longer than it would’ve been if you’d been paying using debit cards. This money in the bank will earn interest and is readily available cash in case you need it.
- A lot of credit cards offer tonnes of benefits to their holders, such as discounts, cash back, card insurance, airport lounge access, and more.
That sounds great. What’s the catch?
A credit card is the worst form of credit. The interest rates are somewhere between 40 and 45% per year, which is insane. Even high-interest personal loans don’t cross 20%. However, if you pay your full amount due before the due date every month, you have absolutely nothing to worry about. Withdrawing cash using a credit card is another deadly aspect of this financial instrument. The instant you withdraw cash, you’re subject to almost 3% interest per day. You don’t get any interest-free period in this case, and to top it all off, banks usually charge you a "convenience fee" when you use your credit card to withdraw cash.
EMIs aren’t really "No-Cost."
As per the RBI’s regulations, no bank can offer you a loan without also charging interest. With no-cost EMIs, the seller usually adds in the interest amount as an upfront discount, providing you with the illusion that you’re not really paying interest. However, since you’re actually paying interest, you also have to bear an 18% GST on the interest amount, which is not discounted in the original price. This 18% GST is in addition to the bank’s processing fee and sometimes even an EMI conversion fee.
Approval for a Credit Card
Banks in India are very cautious about whom they lend money to. You have to prove yourself creditworthy. Banks look at a few things before issuing you a line of credit- your income, relationship with the bank, and your credit score. Your credit score is a 3-digit number starting from somewhere in the 200-300 range and going up to 900. As you might imagine, the higher the number, the more creditworthy you are. In the later sections of this article, we’ll discuss what factors influence this score.
Wait, you might say. How can one have a credit score to apply for a credit card if they’ve never been given credit before? It’s sort of like the "You need experience for an internship" paradox. But, thankfully, in this case, there’s an easier solution to come out of the paradox- secured credit. Banks are afraid to loan you money if it’s unsecured, meaning there’s nothing that the bank can use as a guarantee in case you don’t pay your debt. That’s why it’s boderline impossible to get a low-interest rate unsecured loan. You almost always have to put up some sort of collateral, converting it into a "secured loan". This concept applies to credit cards as well. What I ended up doing was getting a credit card against a fixed deposit. In India, most of the big banks have this facility. All you need to do is open an FD and then apply for a "Credit against FD". This option has a certain number of benefits:
- The bank can issue you a credit card risk-free as you’ve now put up some collateral.
- The credit limit is approximately 90% of your FD balance.
- You receive interest on the FD amount, which is higher than the interest that a savings account gives you for simply parking your money.
- You have a stable form of investment which surely provides very low returns (in fact, it provides you with a negative real return rate after you consider 6% inflation.) But it is still there for you on a rainy day, should you need immediate cash.
In my opinion, there’s no better way to get started in the world of credit. Once you’ve got a credit card via this route, it’s time to head on to the other sections of this article!
Using credit cards for everything
Does the section header sound like clickbait? Sure, Is it really clickbait? Not really. Once you have a credit card, it’s important that you use it well. Credit cards, even the most basic ones, have a lot of benefits that you can avail of if you use your card properly and to its fullest extent. You are awarded cashback as loyalty points via companies like Payback. You’re essentially being rewarded for something you’d have had to pay for, anyway. As a result, I made sure that I was getting the most out of my credit card. However, since we’re talking about spending everything using your credit card, I want to warn you that you should use your credit card like your debit card. You shouldn’t use your credit card for something you couldn’t have paid for using debit. Again, don’t spend money that you wouldn’t have spent, anyway.
The "free money" period
Credit cards provide a 45–50 day "interest-free period". What does this mean? Say your card’s billing cycle starts on the 1st of every month. Consider a billing cycle from January 1st to January 31st. Your bill, therefore, will be generated on the 1st of February. You get around 2 weeks to make the payment. Now, let’s go back a little. Consider that you spent Rs. 1000 on a new pair of headphones on the 1st of January, the day your billing cycle started. You wouldn’t have to pay for it until the 14th of February. That’s a lot of time for you to just leave the money in your savings account, making you money on the money that you were supposed to pay upfront. I usually like to park my money in a high-interest savings account, growing my money without risking it on risky financial assets such as stocks or instruments with a long lock-in period such as bonds.
The 30% Rule
This is something that caught me by storm when I first started using credit cards. Apparently, it’s important to keep your credit utilisation below 30%–40% so that your credit score remains high. I’ve seen my credit score dip by almost 20 points when I used to max out my starter credit card’s balance. The goal is to use only 1/3rd of your entire credit limit. This is the sum of all of your credit limits across all of your lines of credit.
On time is a wonderful thing.
I took that section title from the lovely Indigo airlines. Paying your bills on time is very important to maintaining a healthy line of credit. As I mentioned in the previous section, you get around 2 weeks from when the bill for the month is generated to when the last date for payment is. I usually like to pay my bills about 2-3 days before the due date (for which I use a simple recurring reminder on the Reminders app on my phone). This way, I get to keep the cash that I would’ve had to pay upfront for almost 2 extra weeks. It is important that you pay the full amount due, not only the minimum due. Banks want you to think that paying the minimum amount due will be enough, but if you don't pay your debt in full, you'll pay a lot of interest on the money you still owe.
Your credit score is a 3-digit number that’s maintained by a few credit reporting and monitoring agencies around the country. The biggest of them is CIBIL by Transunion. A good credit score varies slightly among the credit reporting agencies. For example, Experian has a score range of 300–850. Anything above 700 is good, and anything above 800 is excellent. whereas CIBIL has a score range of 300-900. Anything above 750 is a good score, and anything above 820 is deemed to be excellent. When you apply for a line of credit from a bank or NBFC, having a higher credit score may entitle you to receive further benefits, such as a higher credit amount, a lower interest rate, and your choice of tenure to repay the loan. Here are some factors that affect your credit score:
- Payment History: You must pay the full amount due every month before the last day of payment. Even if you pay just the minimum due amount, you’ll be subject to not only high-interest rates but also a dip in your credit score.
- Credit Utilization: Each billing cycle, you must keep your credit utilisation below 30–40%.Using 80-90% of your available credit limit can make your credit score drop as it increases the risk for the lenders. I didn't know about this until I saw that my credit score had dropped 20 points because I was using all the credit on my starter secured FD card.
- Credit Age: Maintaining an existing line of credit makes more sense than closing it. Sure, if you’re really not using the card anymore, you should close the account, but this can affect your credit score, albeit not as drastically as the 2 points mentioned above. Keeping an existing line of credit active by simply using it for one digital subscription per billing cycle should be enough to keep the account active. Just don’t forget to pay the full amount due before the due date!
- Credit Mix: Removingunsecured loans increases the risk for the lenders. Therefore, it’s a great idea to take out a line of credit against a secured asset such as a fixed deposit. This reduces the risk to the lenders and therefore helps in boosting your credit score.
- Enquiries: There are two types of inquiries that can happen: soft and hard. A soft inquiry happens when you request your credit report to check its status. This doesn’t affect your credit score at all. A "hard inquiry" is when a lending agency runs a credit check on you to deem your creditworthiness. This inquiry appears on your credit report. Therefore, requesting too many lines of credit, which makes lenders perform a hard inquiry on your credit report, damages your credit score. To put it simply, do not go to multiple lenders asking for some form of credit too quickly.
Monitor your credit report.
Credit reports are super important. They are the documents that convey your entire credit history, your behaviour in repaying loans, and your personal details concerning debt accumulation. Therefore, it is important that you run a check on your credit report at least once every 6 months. During this check, look for a few things, such as whether all the lines of credit mentioned in your report belong to you, whether all the account details and credit limits associated with that account are accurate, and your personal details. There have been multiple cases of credit fraud, and unless the person reports the fraud within a few months, it becomes hard to claim the damages.
In this article, we went through how to get started and how to handle a credit card. I hope this article helps those who’re just getting started with earning and would like to build their credit scores for their needs in the future. A credit card is a great tool when used correctly, but it is the worst form of credit if it isn’t. Simply use a credit card like you would’ve used a debit card-don’t buy things you wouldn’t have bought using your ATM card in the first place, pay the full amount due on time, keep your credit utilisation below 40%, and don’t forget to check your credit report for fraudulent transactions every 6 months. Thank you for reading!