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 would help someone get their first credit card or some form of a line of credit.
This article was originally published on my blog
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 and 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 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 tons of benefits to their holder such as discounts, cash backs, 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 40–45% 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” for when you use your credit card to withdraw cash.
No cost EMIs aren’t really “No-Cost”
As per RBI’s regulations, no bank can offer you a loan without also taking in 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 to be creditworthy. Banks look at a few things before issuing you a line of credit, such as 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 almost near 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% off 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 is, surely very low returns (in fact, providing you with a negative real returns rate after you consider a 6% inflation.) but it is still there for you for 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 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. I switched all my subscription payment methods to my credit card and therefore ensured that I was making the most use of it.
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 1st Jan to 31st of January. Your bill, therefore, is generated on the 1st of February. You get around 2 weeks to make the payment. Now, let’s go back a little. Consider, 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 in risky financial assets such as stocks or instruments with a long lock-in period such as bonds.
This is something that caught me by storm when I first started using credit cards. Apparently, it’s important to keep your credit utilization 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 is. This is the sum of all of your credit limits across all of your lines of credit.
On time is a wonderful thing
Took that section title from the lovely Indigo airlines. Paying your bills on time is very important to keeping a healthy line of credit. As I mentioned in a 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 fullamount that’s and not only the Minimum Due. Banks like to trick you into thinking that paying the minimum amount due will suffice, but unless you pay what you owe in full, you’ll incur massive interest rates on your outstanding amount.
Your credit score is a 3 digit number that’s maintained by a few credit reporting/monitoring agencies around the country. The biggest of them is CIBIL by Transunion. A good credit score varies slightly by the credit reporting agencies. For example, Experian has a score range between 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, 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: You must keep your credit utilization below 30–40% each billing cycle. Using 80–90% of your available credit limit can make your credit score drop as it increases the risk for the lenders. Personally, I wasn’t aware of this factor until I noticed my score had dropped 20 points because I was using the maximum available credit on my starter secured FD card.
- Credit Age: I’ve seen on the internet that maintaining an existing line of credit makes more sense than closing it down. Sure, if you’re really not using the card anymore you should close the account, but this can affect your credit score, albeit not that drastically as the 2 points mentioned above. Keeping an existing line of credit 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: Taking unsecured 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 up your credit score.
- Enquires: There are two types of enquiries that can happen- Soft and Hard. A soft inquiry happens when you request your credit report to check the status. This doesn’t affect your credit score at all. A Hard Enquiry is when a lending agency runs a credit check on you to deem your creditworthiness. This enquiry appears on your credit report. Therefore, requesting too many lines of credit, which makes lenders perform a Hard Enquiry 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 document that conveys your entire credit history, your behavior at paying back loans, and your personal details related to gaining debt. Therefore, it is important that you perform a check on your credit report at least once every 6 months. During this check, look for a few things, such as if all the lines of credit mentioned in your report belong to you, if 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 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 utilization below 40%, and don’t forget to check your credit report for fraudulent transactions every 6 months. Thank you for reading!