A credit card is a plastic card issued by a bank or financial institution that enables the cardholder to borrow funds for purchases or services up to a predetermined limit, which is dependent on the cardholder's creditworthiness and the terms of the credit card agreement.
By utilising a credit card to make purchases, the cardholder is effectively taking out a loan from the issuer and is obligated to repay the borrowed amount. If the cardholder settles the bill in full before the due date, they can avoid paying any interest; however, failure to do so results in the bank charging interest and other associated fees.
Using a credit card offers several benefits, such as:
Interest-free credit period
When using a credit card, you are not spending your own money; you are spending the bank's money. Furthermore, you may enjoy an interest-free credit period of up to 50 days to repay the amount you spent in a given month.
Pro tip: When you make a purchase with your credit card, transfer the same amount to a separate bank account. You can then invest that money in a fixed deposit or a liquid fund (avoid investing in stocks or other risky products). Alternatively, you can leave the funds in your account and earn interest at the normal savings rate. When your credit card due date approaches, pay the bill using that bank account.
Rewards
Rewards are one of the most significant advantages of a credit card. When you use your credit card to make purchases, your card issuer rewards you. Depending on the features of your card, you may receive reward points, cashback, air miles, and other benefits.
Pro tip: Choose your credit card carefully. In a recently-published Moneycontrol article, we spoke about how to choose the best credit card for you. If you want to earn air miles, select an air miles credit card. If you prefer cashback, choose a cashback credit card. Finally, if you want gift vouchers or a combination of all these benefits, choose a reward points credit card.
Building credit history
Building credit history is crucial as banks use this parameter to determine your overall financial health. A good credit history means banks will readily offer you credit products such as credit cards, loans and more at lower interest rates than someone with poor credit history. Using a credit card and paying your bills on time can boost your CIBIL score, strengthening your credit history.
Fraud prevention
Fraud prevention is another significant advantage of using a credit card. Most credit cards come with built-in fraud protection that can help safeguard you against unauthorised charges, misuse of your credit card or any other fraudulent activity. If you lose your credit card or if fraudsters somehow manage to obtain your credit card details and make unauthorised transactions without 3D security, such as OTP authentication, you can easily dispute these transactions with your card issuer and receive a refund. Furthermore, you can even dispute authorised transactions if the merchant fails to provide you with the promised service or goods. For example, if you purchase a TV from a merchant and the TV is delivered but is not in working condition, and if the merchant denies a replacement, you can file a chargeback claim with your bank. However, in the case of a debit card, we do not normally have access to such facilities.
Insurance Benefits
Insurance benefits are another advantage of using credit cards. Many credit cards offer various insurance benefits such as personal accident insurance, travel insurance, purchase protection, and more. However, it is essential to check the bank's terms and conditions of those insurance benefits carefully. You may discover that these insurance benefits are often useless, except when using super-premium or luxury credit cards.
Also read: Higher spending, missed payments? Your credit card may be cancelled
Let's now discuss the disadvantages of using a credit card.
Overspending
Many people consider overspending as the primary disadvantage of credit cards. However, this is not a problem with credit cards themselves but rather a psychological issue. When we obtain a credit card from a bank, they assign a credit limit, and we spend the bank's money while making purchases. As we don't immediately pay from our bank account or cash, we may become prone to spending more than our actual spending capacity.
Pro tip: To avoid overspending, create a separate bank account to manage credit card expenses. When making any purchase, transfer the same amount from your primary bank account to that separate account and use the fund to pay your credit card bill on the due date. This way, you can prevent overspending.
High Interest Rate of Credit Cards
When you carry a balance on your credit card, the bank charges you interest on your outstanding balance, which ranges from 15 percent to 50 percent per annum. Credit cards can charge you a very high-interest rate.
Pro tip: Never carry a balance on your credit card. If you can't pay your bill on time due to any financial emergency, convert your outstanding balance to equated monthly instalments (EMI) by calling your bank and pay on time.
Credit Cards Can Destroy Your Credit History
While credit cards help you build your credit score, they can also ruin your credit history. If you fail to pay your credit card bill on time, it can badly impact your credit history. The thumb rule for managing credit cards is to be responsible and avoid overspending. It's important to apply for a credit card that suits your needs. If you tend to forget to pay bills on time, it's best to avoid using a credit card as it can harm your credit history. Use your credit card responsibly and take advantage of reward programs that are available. Replace your debit card with a credit card, but be sure not to withdraw cash using your credit card.
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