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How to make the best out of your credit card

Credit cards are an asset to a buyer and to meet emergency expenditures but it depends on the user whether it becomes a liability or not

Harsh Roongta

14 Aug 2007

A credit card is a great help but you should be wary of the costs involved. Here is a little advice on how to use it wisely.

The last decade has witnessed the rise and rise of the Indian middle class, which has made its presence felt in the marketplace with greater consumption, powered by the magic of plastic currency. Credit cards are increasingly being used to purchase high-value mobile phones and consumer durables. To a large extent, youth has been driving this boom, selecting the latest gadgets and influencing purchase decisions in the household. With many credit card companies handing out free add-on cards, credit card spending starts at an early age. However, few are really clued into how credit cards work and what liabilities they can bring on you if you use them without caution.

Today, many credit cards come with no annual fee for the first year, except for some co-branded cards like Gold and Diners Cards, which may be available at an annual fee of between Rs 750 and Rs 2,000. Most banks charge an annual fee from the second year while a few others are lifetime free cards.

Besides that, all the other costs, including interest, are usually dependent on the customer's card usage. In most credit cards, interest rates are 2.95 to 2.99 per cent per month approximately, which translates into about 41 per cent per annum after taking service tax into account. Some banks charge slightly lower at 34 per cent per year. And of course, there are several other costs like late payment charges, overlimit charges, rollover charges, tax on rollover, etc, which can completely confuse you.

So here are a few do nots while using your credit cards:

Never use them to meet long term expenses - For instance, you should not purchase an automobile/vehicle even if you card allows it. You should do so only if you have that kind of money in your savings account or through an auto/vehicle loan. The first option is best, but the second option is definitely cheaper than the expense on a credit card.

Never use it to cover shortfall in income - Customers also use credit cards to meet the continuous shortfall in their income. If your salary is Rs 20,000 and your expenses are Rs 30,000, you are living beyond your means. You should not use credit cards to meet these expenses; a credit card is not designed to meet a shortfall of funds. "If a customer does this, he is getting into a debt trap", warns Dheeraj Dikshit, Senior Vice-President, cards and personal loans, HSBC India.

Withdraw as little cash as possible - Borrowing on your card is not the smartest thing to do, as there is a higher cost attached to it. Suppose you are travelling and need emergency funds, you can withdraw cash up to 40 per cent of your credit limit in cash. If your credit limit is Rs 15,000, you can withdraw Rs 6,000 where you start paying the interest from the time you start taking the funds. Hence, the best way out is that you refund the amount as soon as you reach home.

Over the years, credit card companies have also got smarter and now offer varied services like converting high value (i.e. above between Rs 2500 - 5,000) purchases to EMI-based products such as 'loan on phone.' Here, the customer can repay his high-value purchase or, in the case of some banks, even his outstanding balance, by converting it to a 'loan on phone' or personal loan, where the interest rates are 50 per cent lower, at 18 to 21 per cent per annum as against regular credit card rates, which are 41 per cent per annum. He gets the benefit of repayment of the principal in fixed tranches over a longer period of normally 12 months in the case of 'loan on phone' and more in case of a personal loan.

How to get out of a debt trap if you are overexposed on your credit card:

Says Dheeraj Dikshit, "we recommend that long-term funding needs be managed through relatively lower interest rate and longer-duration products such as personal loans, where the average rate of interest and duration is 18 per cent and four years respectively. While this will enable the customer to meet an urgent requirement or commitment that is in excess of his/her current cash flows, it will also ensure that debt servicing does not constitute a large component of his income and thereby impair repayment ability."

Financial consultant S Ravi Kumar advises that the best way for a customer to get out of a huge outstanding balance is to take a loan against his fixed deposits in a bank or against his LIC policy, or provident fund. The interest rates on these would be much cheaper and on a reducing balance. With that loan, he can pay off his credit card outstanding, which would otherwise prove to be very costly.

In short, a credit card is an asset to have as it helps you to make important purchases, meet emergency expenditures and make payments in a phased fashion. However, it entirely depends on you whether you make it a liability by overexposing yourself.