Credit cards are a common financial tool that allow you to borrow money from a lender to make purchases. They give you the luxury of having cash available to you anytime.
You can use them for shopping, booking online movie tickets, air tickets or train tickets, online fee payments, insurance premium payments or fuel refills at fuel stations. Spending on credit cards also offers rewards, discounts and cashbacks as per the offers. For all this spending, it is not necessary if you have cash in your bank account or not.
They offer convenience and flexibility, but also come with risks if not used responsibly. This luxury of always available cash can ruin your finances if you don’t use your cards fairly. You have to pay the credit card bills regularly and timely to make their best use. Otherwise, you can easily get trapped in credit card debt very badly even before you realize it.
In this guide, we’ll explore the basics of credit cards and provide tips for using them wisely.
Table of Contents
- What Is a Credit Card?
- How Does A Credit Card Work?
- Credit Card Benefits?
- How To Get a Credit Card
- How Long Does It Take To Get A Credit Card?
- How To Use Credit Card Responsibly?
- Building and maintaining good credit with credit cards
What Is a Credit Card?
A credit card is a financial tool that allows you to borrow money from a lender to make purchases at merchant stores. Each card comes with a credit limit, which is the maximum amount of money you can borrow at any given time for shopping or spending.
The amount of money you can borrow is determined by your credit limit, which is based on factors such as your credit score, income or your previous credit history if any. Some lenders issue credit limit against your fixed deposit amounts also.
You can use your credit card to make purchases online, in stores, or over the phone, and you can also use it to withdraw cash from ATMs.
This borrowed money or loan is totally interest free if you keep paying your credit card bills on due date. Interest is levied if the bills are not paid on due date.
Important thing to remember is that this credit is free only in two conditions :-
- If the card is used only for shopping and at merchant sites. This does not include cash withdrawals.
- If you payback the entire amount spent to the lender by the payment due date.
If you use your card to withdraw cash from the ATM machine, then this credit amount is not free There is a onetime fee for the withdrawal transaction and much higher interest charges on the amount withdrawn.
Credit cards are different from the debit cards. You can use a debit card for spending only if you have cash in your savings bank account. In case of credit cards, you do not need to have money in your bank account to make spending. It is a credit or borrowed money, given by the credit card issuing institution. Visa, Mastercard and American Express are the major credit card payment networks.
How Does A Credit Card Work?
After you are issued a credit card, a billing cycle is assigned to your credit card account. This is like a revolving account.
You will receive a monthly statement that shows your balance, minimum payment due, and any interest charges or fees. It’s important to use your credit card responsibly and pay your balance in full each month to avoid accumulating debt and damaging your credit score.
Now, let us understand how a credit card works !
The specific credit card information you must know :
- 16 digit unique credit card number – printed on the front of the card
- Credit card expiry date – printed below the credit card number
- Card Holder Name – printed on the front of the card
- 3 digit secret CVV number – printed behind the card
- 4 digit PIN number – it is confidential and not printed but provided to the holder
You can use credit card for offline shopping or online shopping.
A particular date is assigned to your credit card account, on which all the spending we made on a credit card are added up. A bill for credit card is generated on this date which is called as credit card statement. Amount billed in the credit card statement is called as the total amount due.
After statement generation, around 15 day period is given to pay the bill amount to the lender or the Credit Card issuer bank. The date by which you have to pay the bill amount is called as the payment due date.
Not making payment before the due date attracts penalty as well as interest charges.
You have two options to make payment. Either you can pay the entire due amount by the payment due date. If you pay entire amount, then there are no interest levied to you.
Alternatively, the card issuing bank gives you the liberty of paying 5% amount of the total amount due. This amount is called as minimum amount due. This is the amount you must pay by due date.
Paying minimum amount due on or before the Due date does not attract any penalty. You need to pay interest charges only. Interest rate charges are levied on the outstanding amount only, the amount left after paying the minimum amount due.
Interest rate charges levied by the credit card companies are very high as compared to the routine interest charges you need to pay for a personal loan.
Credit Card Interest Rates
The borrowed money used for spending is totally interest free till the payment due date. This is interest free period which is normally between minimum of 20 to maximum of 52 days. No interest is levied to you in this time period.
However, if you do not pay the total amount due on or before the payment due date,then you will be liable for interest charges. If you do not pay even the minimum amount due before the due date, then you become liable for penalty also which is in addition to the interest charges.
Credit card interest rates of nearly 1.5% per month are imposed on the outstanding or balance amount. It comes out be around 36% per year as compared to a personal loan which you may get for around 9% per year.
Understanding Interest Rates, Fee and Statement Generation
Let us understand the credit card functioning with an example. I hold an ICICI Bank credit card.
The credit limit for it is fixed at ₹ 1,70,000. This means I can make maximum spending of that much amount on my card. credit card statement is generated on date of 28th of every month. Payment due date is fixed at a date of 15th or 16th of next month depending upon if the month gone by was of 31 or 30 days respectively.
Now to avoid any kind of charges, I need to pay the total amount due on or before payment due date. Then the credit amount I used for my expenses will be totally free.
So, I get interest free credit for maximum of 45 days if I had made spending on date 29th. It is 30 days of monthly cycle and 15 days I get to make payment by payment due date. If I make spending on 27th of a month, then I get 18 days of interest free credit because bill or statement will be generated the very next day I.e. on 28th.
Now coming back to the payment to be made, I can also opt for paying a part of the total amount due which is the minimum amount due. This is the 5% of total amount due.
Paying minimum amount due ensures that you didn’t get penalize but only need to pay the interest charges on the outstanding bill amount.
The outstanding amount is subtracted from the credit limit. So your credit limit is reduced till you clear all the dues.
Credit Card Benefits?
There are several benefits of having a credit card;
1. It ensures you have always money at your fingertips. You can avail the benefits of time-to-time discount offers on shopping even when you are short of cash in your savings bank account.
2. Using a credit card for transactions results in reward points. These are free incentives offered by the card issuing companies. You can use the reward programs to redeem these points for free gifts or to make payment to your credit card bills.
3. Making payments on fuel stations with credit cards offers cash discounts by most of the card issuing companies. Discounts may not be much but whatever you get is good. At least you can use these discounts to pay toll charges on highways.
4. If you are having a good payment history towards credit card bill payments, you are offered personal loans with time to time offers. These are the easiest kind of loans available as they require nil or little paperwork.
5. Having a credit card with good payment history helps you build good credit score. This helps you get loans easily sanctioned at the time of need.
6. If you have more than one credit card, you can use the facility of balance transfer to get interest free credit for some more time. If this facility is available on your card, you can transfer the balance amount from one credit card to the other card. Some card issuers also offer lower interest rates when balance transfer is availed.
How To Get a Credit Card
To get a regular credit card is a tough task as compared to the student credit cards. This is because of the required documentation and a lengthy verification process. As credit cards are unsecured loans, the card issuing companies take lot of care before a card is issued to you.
The card issuers have to ensure that you will be able to make timely and asked payments to the companies on due dates. People with regular employment and a handsome salary are relatively better placed to get a credit card issued.
List of documents required to apply for a credit card :-
- Identity proof document
- Residence proof document
- Proof of your current employment
- Income or salary proof certificate
- Last six months bank statement
- Passport size photographs
After you provide all these documents and the card issuing company is satisfied with the verification process, you may get your credit card in one to two weeks of time. It is delivered at your residential address in a registered post.
However, if you are unable to get a credit card through this process, you can get it as a secured loan. You can get a credit card issued to you against your fixed deposits or balance maintained in your savings bank account. However, the credit limit of such credit cards is only equal to the fixed deposit or balance maintained. If you fail to make bill payments, the card company can get the money back from your deposits.
Different companies offer different types of credit cards ; like american express, platinum cards, forex cards to name a few. A forex card is an international credit card which is more useful to frequent travellers. The companies may charge credit card fees at the time of joining and on annual basis while some are life time free with no annual charges, depending upon which credit card we opt for.
How Long Does It Take To Get A Credit Card?
How long does it take to get a credit card depends upon your personal profile. Credit card issuer will issue you a credit card only if they believe that you can make payments back to them. Usually you may get a credit card from 2 weeks to a month time.
If you are an employed person with a good carry home salary, you can get a credit card easily.Just submit your salary statement with the application form.
You can get instant credit card against a fixed deposit (FD) with the credit card issuing authority. The credit limit sanctioned to you is equal to the fixed deposit amount.
How To Use Credit Card Responsibly?
Having a credit card gives you so much cash freedom or leverage. It is very useful in emergencies when you are short of cash. You do not have to wait to buy something till you have required money if you hold a credit card.
But it is very important to use credit card responsibly. Otherwise, it can make your life miserable if you get stuck in credit card debt. Credit card rates are very high and you can easily get trapped in a credit card debt.
Another very important thing to remember is that you should never share your credit card details with anyone. The card issuers always keep warning their customers against it. It is a step to prevent the online frauds on cards.
Always Pay Total Amount Due
First and foremost, important thing is that you pay the total amount due by the due date. Don’t get carried away by the luxury of paying minimum amount due.
Keep in mind that paying total amount due by due date keeps all your spending transactions interest free. If you pay minimum amount due, the outstanding amount, of course, is charged but even the future spending transaction you make also start attracting interest charges from that very day you made it. Now they are no longer interest free.
So, the outstanding amount starts piling up on due to high rates of interest. Over the time it becomes very difficult to clear those balance amounts.
Invest Your Liquid Cash To Make It Grow
You can keep using your credit card for your daily routine expenses. Leave the liquid cash you have in your savings bank account to grow.
The banks give interest rates of about 3% on the idle cash you hold in your savings account. Alternatively you can opt for short-term fixed deposits or liquid mutual funds to get higher returns.
When the payment due date nears, dissolve the fixed deposits or the liquid funds and pay total amount due as per statement.
Be Vigilant toYour Expenses
Keep your credit utilization ratio (the amount of credit you’re using compared to your credit limit) below 30%. Avoid using your credit card for impulse purchases or things you can’t afford.
Monitor your account regularly for any unauthorized charges or errors. Always keep an eye on your spending through credit card.
By making payments through a card, you don’t feel the pain of money slipping out of your hands which we normally do while making cash payments. This may lead to overspending.
Never Use Credit Card For Cash Withdrawal
Never use your credit card to withdraw cash at the ATM machines except in dire emergency. If you have to, pay back as soon as possible.
Split Big Transactions Into Smaller
If you have made a big amount transaction on your credit card and it is not possible to payback full amount, get it converted to equated monthly instalments (EMIs). Doing so attracts lower interest rates of around 12% as compared to normal rates of around 36% per year.
Keep Limited Number of Credit Cards
Don’t apply for too many credit cards at once, as this can negatively impact your credit score.
Building and maintaining good credit with credit cards
Credit cards can be a powerful tool for building and maintaining good credit score. By using your credit card responsibly and making on-time payments, you can demonstrate to lenders that you are a reliable borrower. This can help you qualify for better interest rates on loans, mortgages, and other credit products in the future.
However, it’s important to remember that building good credit takes time and effort. Be patient, stay on top of your payments, and avoid taking on more debt than you can handle.