Credit cardholders, just like consumers of other financial products, harbour various myths and misconceptions about credit cards. Many of these myths refrainthem from making optimum use of credit cards. Apart from foregoing credit card benefits, these myths can hurt their credit score and overall financial health.Let’s discuss some of the most widespread myths related to credit cards.
Credit cards are harmful to your financial health
Many people avoid credit cards due to their fear of falling into debt trap from increased spending and high interest rates. Although the risk of falling into debt trap is very real for those lacking financial discipline or prone to impulsive spending, credit cards can be beneficial for one’s financial health.
First, it is an excellent tool for building credit history for those who never availed loans in the past. As with any loan, credit card transactions are reported to credit bureaus, which are then used to calculate the credit score. Second, credit card transactions come with interest free period of up to 50 days as long as the entire bill amount by the due date. This can help in managing your cash flows, especially in case of big ticket spends. And finally, credit cards come with attractive cashback offers, discounts, reward points, free lounge accessetc., which if managed well can save substantial sum of money.
Finance charge is not incurred on paying minimum due amount:
Credit cardholders oftenassume that paying the minimum due amount would save them from incurring finance charges. However, paying minimum due amount will save you only from incurring late payment fee. You would still accrue finance charges on the unpaid bill amount. Additionally, non-payment of the entire bill amount can also lead to the withdrawal of the interest free grace period on fresh card transactions till the repayment of the outstanding bill amount. Hence, always make sure to pay your entire card bill by the due date or else convert it into EMIs.
Avoid increasing credit limit
Many credit cardholders avoid increasing their credit limit owing to the fear of increased spending. If used judiciously, opting for higher credit limit can help improve your financial health. First, it will give you more room to manage financial emergencies. Additionally, a higher credit limit would reduce your credit utilisation ratio, i.e. the proportion of total credit limit used by you. A reduction in credit utilization ratio would gradually increase your credit score, which in turn will increase credit card and loan eligibility.
Try to maintain credit utilization ratio within 30% as lenders consider those exceeding the said limit as credit hungry. If you too are frequently exceeding this limit, ask your existing credit card issuers to increase your credit limit or opt for an additional card.
Closing credit cards will improve your credit score
Closing unused credit card may reduce your credit score, at least in the short term. While closing the existing card will result in savings in terms of annual or renewal fee outgo, doing so would reduce your credit limit and thereby, increase credit utilization ratio. Closing your old credit cards might reduce your credit score in the short term, given that it will bring down total available credit limit, thereby increasing your credit utilization ratio.
As those with higher average age of credit accounts are treated favorably by credit bureaus, closing older credit card(s) will reduce the average age of your credit facilities and credit score. Hence, before closing your existing credit cards, try increasing the credit limit of your other credit card. Opt for additional credit card(s) if the existing card issuer(s) refuse to increase the credit limit.
By Sahil Arora, Director & Group Head, Investments, Paisabazaar.com
