Dangers of Using Credit Cards

Planning to get yourself a new credit card?

Scared about its potential dangers?

Many people opine that credit cards are dangerous. New credit card users can easily get swayed by the offer of "free money" that credit cards bring along and lose control of their expenditure. Even experienced users often end up in credit card debt. It is of prime importance that you understand the potential dangers that accompany your credit card subscription and learn some smart techniques to keep yourself safe. Read ahead to know how you can cultivate responsible credit card habits.

The Infamous Credit Card Debt

Credit card companies are not exactly your best buddies. They don't give you "free money." They are neither very generous when they tell you that you need not repay the entire borrowed amount within the billing cycle. These offers are so lucrative that we fail to realize the harsh consequences. We tend to borrow a lot more than required a lot more than we can afford to pay back. There's a larger game at play here, which might as well be beyond your comprehension.

Let me elaborate with an example. Say you have a credit card with a credit limit of Rs.1,00,000. That doesn't mean you should spend it entirely. Let's say you have spent Rs.30,000 and your credit card company tells you that if you repay a small amount of Rs.3,000 fn the current billing cycle, you're good to go. You feel overjoyed and pay the nominal amount. You don't realize that a huge rate of interest will be applicable on the remaining Rs.27,000. You might be spared of the burden of paying big bucks at the moment, but you'll end up paying more than you had originally borrowed. Also, if you get into the habit of procrastinating your payments every month, you will inevitably fall into credit card debt.

Lessons learned:

1. Don't be a spendthrift. Spend responsibly. Avoid spending more money than you can afford.

2. Repay the entire credit balance accumulated in each billing cycle.

3. Create a monthly budget for yourself and strictly adhere to it.

Missing Your Payments

Missing a payment can be a stumbling block. Your payment history greatly affects your credit score; and if you fail one, you are sure to suffer. Your credit score will drop, you will have to pay a late fee, and you might also have to pay a high-interest penalty (penalty APR). If the payment is delayed by 30 days, your card-issuing company might report the incident to the credit bureaus, messing up your credit reports for up to seven years.

Lessons learned:

1. Never miss a payment

2. Set up automatic payments

3. Set up text/mail/phone reminders for yourself

Carrying Forward Your Credit Balance

As we discussed a while ago, credit card companies usually give you the option of paying "just a nominal amount" every billing cycle instead of settling the entire loan. If you do this, you carry forward a balance to the next month. If you keep doing this every month, the amounts accumulate to form a huge debt. This money can incur a significantly higher rate of interest. And we all know that credit card interests can be notoriously high.

It is important for you to understand what the APR is. It stands for Annual Percentage Rate. It can go up to an incredible high of 16%. If your credit score is low, the APR can be even higher. A penalty APR applies to the due amount when you fail your payments, and is higher than the standard APR.

On the other hand, if you repay your entire credit balance within your billing cycle, you are spared from paying these high interests.

Lessons learned:

1. Make payments on time

2. Repay the full borrowed amount within each billing cycle

3. In case of exigency, apply for a balance transfer card - a loan facility that helps you settle a high credit balance at a lower interest rate

Too Many Credit Cards to Handle

As you apply for a new credit card, the issuer checks your credit score. This checking qualifies as a hard inquiry. You surely do not want a lot of hard inquiries on your plate, as it affects your credit score. They also turn up in your credit report. Too many hard inquiries show desperation on your part, and the lenders would doubt your creditworthiness.

You need to decide which credit card you actually want, and avoid applying for many. Simultaneously, you could try to assess which cards you would get an approval for and apply accordingly. You might also lose track of your cards if you have multiple ones, resulting in missed payments or auto-cancellation of cards that are inactive. All these can lead to a drop in your credit score. The aim is to ensure that you keep a firm grip on your cards and your expenditure and do your best to maintain a high credit score.

Lessons learned:

1. Avoid applying for too many credit cards at once.

2. Research well before applying for a new credit card.

3. Think and choose reasonably before applying for a new credit card - don't apply for one that you're unlikely to get.

4. Some online financial tools and apps compare your credit profile with that of others and assess your chances of getting a particular credit card. You could consider trying one of those before applying for a new card.

Controlling Your Credit Limit Usage

The bank might give you a high credit limit, but you're expected to spend only up to 30% of it; or else your credit score takes a hit. The ratio between your expenditure and credit limit is called 'Credit Utilization.' Lenders judge your creditworthiness through this ratio - if you spend too much, you might not be able to repay; hence it is risky to lend money to you.

If by any chance, you have a high credit utilization ratio, credit issuers will either refuse a new credit card for you or approve a credit card with a high rate of interest.

1. Keep your credit utilization under 30%.

2. Put yourself on a budget and control your expenditure.

3. If your credit utilization exceeds 30% regularly, consider applying for an increase in credit limit.

To Sum Up

Credit cards can be quite risky, but you can control and minimize their impact by setting up a few boundaries for yourself. Be a disciplined spender; don't ever fall into debt. Developing good financial habits will let you comfortably enjoy all the perks that credit cards offer. It is also essential to check your credit score regularly to keep track of your credit health.