Credit cards have become an integral part of our lives. They come with a 45-day interest free period. When used smartly they can help you manage your expenses better. In fact, one can earn points by spending through credit cards which can be used to make other purchases.
But if not used wisely, a credit card can land you in a debt trap. Interest on credit cards can be as high as 3.5 per cent per month, which translates to 42 per cent per year.
“Treating credit cards as an asset is a serious blunder. It’s not “free money”. What you are spending today, you need to pay off tomorrow,” says Arijit Sen, a Sebi-registered investment advisor and co-founder of Merry Mind, a Kolkata-based financial advisory firm.
Once you get into credit card debt, it is very difficult to come out. Let us look at some of the common mistakes that will land you in credit card debt.
Paying the minimum amount due
The problem starts when you spend money you do not have. Also, when the credit card due date comes, you do not have enough money in your account to pay the bill. Credit cards will give you the option to pay a minimum amount on the payment for which you are excused from paying your late fees and can continue using the credit card.
“Repeatedly repaying the minimum amount due is a big mistake. It is a misconception that paying just the minimum amount due does not attract interest cost on the outstanding amount,” says Sen.
Here is what happens. Credit cards charge you the steep interest rates mentioned above on the unpaid portion of your bill. Also, once you have an unpaid amount, the interest free period is revoked on any further transactions you make, till you make the payment. Thus, when you use your credit card again, you start paying interest from day 1.
Not paying your credit card bills in full for months together and further credit card spending can land you in a serious debt trap.
You can convert such debt into EMIs and pay lower interest, but it means you get into a debt-paying cycle that can last several years.
So, it is a mistake to swipe your credit card and pay for items you cannot pay for right now through cash or a debit card.
Using your credit card to withdraw cash at an ATM
If financial mistakes could be ranked in the order of how bad they can be, using your credit card at an ATM to withdraw cash would rank on top. Remember, there is no interest-free period for such withdrawals and the high rate of interest kicks off immediately. Plus, you will have to pay a cash advance fee of 3.5 per cent. You keep on paying interest charges till you have repaid the entire amount.
Always plan your credit card purchases and spend it only on things you would have spent on anyway. Sen has a word of caution, especially since the festive season is here. “People often do not set a budget for shopping/purchases, especially during the festive season. Carrying credit cards during unplanned shopping/purchases is a typical mistake. This will create unnecessary pressure in cash flows in the following months.”