Use credit card wisely to stay away from debt trap

There are several common misconceptions around credit card debt. Just as with any kind of debt, you must educate yourself about credit cards and the best ways to use them. Credit card debt is expensive. If you find yourself pulled into one where you are unable to settle your dues, here are some mistakes you should avoid.  

KEEP SPENDING

If you are struggling to settle your credit card dues, the first thing you should do is stop using the card. The last thing you need is even more debt accruing on your account, which will pull you deeper into a debt trap. Credit card interest rates can be in the two to three per cent per month range. This may sound harmless but when annualised, this is a significantly high rate of return over 40 per cent in some cases. Therefore, pause your card use and work on a repayment plan. Since this is high-interest debt, it should be settled on priority.  

MISSING PAYMENTS

Missing your credit card payments is a terrible idea. Ignoring payments reminders and thinking the debt will disappear on its own is even worse. All your debts are reported by your lenders to credit ratings agencies who use this information to compute your credit score. Your credit card activity will show on your credit report for years. Missed payments lead to default, which will wreck your credit score. This will make it difficult for you to take a loan or get a credit card again. Therefore, keep up with your credit card payments for the sake of your financial future.   

CANCELLING YOUR CARDS

The age of your credit card account reflects positively upon you. The longer it is, the higher its contribution towards your credit score. An open credit line shows that you have managed to settle your debts in the past. Therefore, if your problem is undisciplined credit card use, you may want to work on your discipline. You can keep the cards in your pocket and not cancel the account on an impulse.

MAKING CASH WITHDRAWALS

One of the worst ways to use your credit card is to use it for cash withdrawals. Non-cash transactions on your credit card can be settled during an interest-free period where you are charged nothing extra. This period typically ranges from 30-50 days for most cards. However, cash withdrawals from credit cards don’t have an interest-free period. Interest and any applicable charges apply from the first day of the transaction. Therefore, avoid ATM transactions with the credit card, especially if you are already in card debt.

MAKING MINIMUM PAYMENTS

Credit cards typically ask you to make a five per cent minimum payment, which you need to make to avoid late payment penalties. However, you must know that the other 95 per cent dues still remain, and it will start attracting interest after the interest-free window. The more you delay settling your burgeoning dues, the bigger will be your interest payments. For example, let’s say you start the year with a card balance of Rs 5,000 and make only five per cent minimum payments for the next 12 months without new transactions. Your interest rate is three per cent per month. In 12 months, you would have paid Rs 2,669 as minimum payments. But your dues at the end of the year will still be Rs 3,852. This means that though you have paid 53 per cent of your dues at the start of the year, your money went mostly towards interest, and you have only made 23 per cent progress in getting out of debt.

NOT READING YOUR CREDIT REPORT

Lastly, if you are a credit card user or have taken a loan from a regulated lending institution such as a bank or NBFC, it would be a folly to not keep track of your credit score. If you are drowning in credit card debt, it is especially important for you to get a copy of your credit report to know if your score has taken a hit. Therefore, keep an eye on your credit report. You can get a free copy of your report once every year from credit rating agencies such as Experian and CIBIL.  Credit card debt is a serious matter and needs to be managed with care. Used wisely, a credit card can make your credit history look really good. Used badly, there can be unforgiving consequences on your financial health.

– The writer is CEO, BankBazaar.com