Borrowings: Swiping your credit card? Think again

Reckless purchases via credit card, late payment and rolling over the credit can lead to a debt trap. And unpaid dues can affect your credit score

After the Covid-19 pandemic, credit cards have emerged as one of the most popular modes of digital payments. The increasing use of credit cards suggests consumer demand for innovative financing options and credit constructs in an increasingly digital ecosystem. For most banks, the card issuance process is end-to-end digital, with video verification to expedite the know-your-customer (KYC) process.

The credit card to debit card ratio, a key indicator of increased acceptance of credit card, has risen to 7.5% in January this year from 6.9% in the same month last year and the credit card to debit card spends ratio has risen to 1.5x in January this year from 1x in January last year, data from an analysis done by Axis Securities shows.

For the current financial year till January, credit card spending has clocked 57% year-on-year growth to Rs 7.81 trillion from Rs 4.98 trillion during the same period in 2020-21. The increased card spending is on the back of growing discretionary buying, a pick-up in domestic travel and gradual re-opening of international travel.

Credit cards are secure and convenient to use. However, reckless spending, late payment and rolling over the credit can lead to a debt trap. Long delays and unpaid credit card dues will affect your credit score and banks may not be willing to give you an education, vehicle or even a home loan.

So, to avoid getting caught in a credit card debt trap, here are four factors to be kept in mind before swiping the card.

Look for a card with low costs
Look for a credit card that charges lower interest rates and nil or lower annual charges. Credit card issuers levy charges such as cash advance fees, late payment charges, ECS / check bounce charges and statement requests for beyond three months, among others. Experts say credit card cashbacks can entice cardholders to spend more, which can later lead to a debt trap if the individual is unable to pay the outstanding due on time.

Use card rationally
The credit limit is decided by the credit card issuer at the time of issuing the card. Ideally, use credit cards for emergencies or for fixed or recurring monthly expenses. Most banks give a credit window of 4-5 weeks from the day of spend to the date of the billing cycle. Over that particular period, credit card spend is like an interest-free loan, provided you repay the amount before the due date. Ideally, you should pay the entire outstanding amount. However, if you are facing a cash crunch, then you can pay more than the minimum amount due, which is calculated as 5% of balance outstanding, or the sum of all installments, interest / other bank charges and the amount utilized over the credit limit, if any.

Avoid rolling over credit
Rolling over credit in a credit card is a lot more expensive than a personal loan. Banks can charge an interest rate of 3-4% per month for all outstanding dues rolled over and the interest is charged on the daily balance on your credit card. So, if you are rolling over the credit, try not to use the same card for any transaction till you clear the entire outstanding due. As banks will charge interest for all transactions during that period, which will compound the outstanding dues and lead to a debt trap. Existing credit card holders should look for a low interest card and then transfer the outstanding debt from the card with higher interest rate to the one charging less. This will reduce the interest outgo and help avoid any debt trap.

Payment default hits credit score
If you are unable to pay the credit card bill on time, your credit score may take a hit. If unable to pay the outstanding due, it is better to convert it into equated monthly installments and pay them regularly. Otherwise, take a personal loan, where the interest rate will be 15-20% per annum, to clear off the credit card due. Avoid any kind of debt settlements with the bank as it will affect your credit score.

Living on credit
Look for a credit card that charges lower interest rates and nil or lower annual charges.
Use credit cards for emergencies or for fixed or recurring monthly expenses.
If you are rolling over the credit, try not to use the same card for any transaction till you clear the entire outstanding due.
If you are unable to pay the outstanding due, convert the amount into EMIs and pay them regularly.

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