The only way to contain the risk of overspending is to maintain a strict financial discipline.
While Credit Cards have become extremely important in not just carrying financial transactions, but building a strong credit history, they also can cause turmoil in your financial life if you are irresponsible in using it. Here are the major risks associated with using credit cards and tips on containing those risks.
Overspending: Credit card can be risky instrument for those who cannot control the urge of splurging money. The easy availability of credit not only reduces the sting of making payment, it also stimulates their desire to buy or consume more. Their exciting reward points, discounts and cashback offers also entice many to do unnecessary expenditures. As a result, many end up in spending more than they can afford to repay.
How to avoid it: The only way to contain the risk of overspending is to maintain a strict financial discipline. Check your outstanding credit card amount regularly to keep a tab on your spends. If you are spending more than you should through your Credit Card regularly, you may consider keeping your credit card at home when going out and using other means like debit card, mobile wallet or cash.
Reduction of credit score: As credit card transactions are equivalent of taking loans, credit bureaus record late payments or defaults in your credit report and reduce your credit score accordingly. Another major factor that reduces your credit score is your higher credit utilisation ratio. This ratio is the proportion of your total outstanding credit card balances against your total available credit limits. As lenders consider a credit utilisation ratio of over 30–40% as a sign of credit hungriness, credit bureaus reduce your credit score on breaching this level.
How to avoid it: Ensure to pay your full bill amount due by the due date. Those who fail to remember bill due dates should set standing instructions in their bank account to enable automatic deduction. Those who frequently breach the 30–40% level should request their card issuers to increase their credit limits or apply for another credit card. However, never apply with multiple credit card issuers within a short span as that too is considered as a sign of credit hungriness. Instead visit credit card marketplaces to choose the best card available on your credit score, monthly income and other criterion.
Credit card fraud: Fraudsters usually initiate the credit card fraud by duplicating your card (skimming) at point of sale (POS) terminals or ATMs or by accessing your details through e-mails or over the phone. They may also resort to identity theft by using your personal details to avail a new card in your name.
How to avoid it: The only way to reduce your credit card security risk is to stay vigilant. Never share sensitive card details with others and always ensure to have your card swiped in front of you. Get your credit report at regular intervals to detect identity thefts and other card frauds. Lastly, inform your credit card issuer as soon as possible on losing your credit card or detecting suspicious transactions.
High interest cost: Credit cards charge interest rate, also known as finance charges, on non-payment of the entire bill amount by the due date and on withdrawing cash from ATMs. These charges can range anywhere from 22 to 47% p.a. While most incur this charge due to financial constraints, many do so because of their sheer carelessness or their misconception of Minimum Amount Due. Paying the ‘minimum amount due’ does not save you from finance charges, it only saves you from paying late payment fee. Once you fail to repay your entire bill amount, all fresh transactions too will attract finance charges as long as the older unpaid balance is not paid.
How to avoid it: Try your best to pay off your entire bill amount and avoid ATM cash withdrawals through your Credit Card as far as possible. In the event of failing to pay the entire bill amount, request your card issuer to convert your existing dues into EMIs. Else opt for balance transfer or personal loan as their interest rates are lower finance charges. Avoid fresh transactions through that credit card till you pay off the existing dues.
Opting for the wrong card: With each credit card issuer offering scores of cards with varying features, charges and benefits, selecting the right or the most suited credit card can be tricky. As most credit cards are aimed at specific customer groups and spend-types, choosing a wrong credit card may entail a sizeable opportunity cost in terms of reward points and other benefits.
How to avoid it: Always analyse your spends carefully before selecting a credit card. Opt for the one that offers maximum benefits on your top spends at lowest cost. For example, a frequent air traveller using his fuel card for buying air tickets would save more money on routing those transactions through an airmiles card. Also compare their finance charges and expiry period and monetary value of their reward points. Never choose a card just on the basis of its joining bonuses.
By Sahil Arora, VP& Head of Payments Products @ Paisabazaar.com