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Soon after you get your first salary, you might want to get access to money on credit to be able to buy beyond your immediate means. It’s not an aberration, but one ought to be careful. There is nothing wrong in using a credit card on a regular basis so long as you manage to save yourself from falling into a debt trap. Paying your credit card bills on time is vital to avoid paying far more than one borrowed. It might sound tempting to buy now, and pay later – but remember that the longer you take, the more you end up paying.
There are some key tips one should remember:
You should make sure not to use the entire credit limit. A higher rate of credit utilisation ratio will impact your credit score. The experts recommend the rate of credit utilisation be kept around 30 percent. Higher the credit utilisation, the lower your credit score. This is why you can request the bank to raise your credit limit if your expenses are on a rise. For instance, if your credit card limit is ₹3,00,000 and credit expenses amount to ₹2,50,000 – then you would exhaust 83 percent of your credit limit. Instead, if you raise the credit card limit to ₹5 lakh -- then credit utilisation declines to 50 percent.
The banks also, from time to time, raise the credit limits of customers who have a good credit score.
Initially, when the credit card is issued the credit limit that is allowed is a multiplier of monthly salary – around 2.5 to 3 times. So, if a person earns ₹50,000, his credit card limit may vary between ₹1,25,000 to 1,50,000 -- though this is not a rule of thumb. However, there are other factors that determine the credit card limit.
These include your debt-burden ratio and pattern of spending, among others. The debt-burden ratio is calculated by dividing monthly instalments by your total salary. The credit card companies can lay their hands on the data of spending patterns from airlines, clubs and online merchants.
Why not pay only the minimum charges: After making a purchase through a credit card, the credit card statement you receive will have two charges –monthly charges and minimum charges. The financial advisors advise that one should pay the month’s full charges to avoid carrying forward any outstanding balance from one month to the next. The only advantage of paying the minimum charges is that you will not be charged the late fee in the next month, but it will charge the interest.
Now, let us see what happens when you only pay the minimum charges. If you have ₹5,000 as monthly outstanding and the minimum charges could be a small fraction of it, say ₹500. In case you decide to pay only the latter, then the next month, your charges will include the outstanding for the next month plus monthly interest on the last month’s due. If the interest is charged at the rate of 3 percent per month then this month’s charges will be ₹5,000 (this month charges) + 4,500 (balance carried forward) + 135 (interest) = 9,635. When you find it difficult to pay ₹5,000, you can imagine how difficult it will be to pay ₹9,635 a month later. And with each successive month, the dues will continue to rise.
On an outstanding amount of ₹10,000, extra interest (at 3 percent per month) comes to ₹3,600 – which you could have avoided if the credit card balance were cleared every month -- and not just minimum balance.
In order to avoid falling into a debt trap, you should follow these important tips:
1. Always make sure you pay on time. If you happen to miss a payment, the next due instalment will be higher since it will not only include the two instalments, but also the late fee.
2. Instead of paying the minimum due, try to pay the entire due amount for that month. Each month, you should start with a zero balance.
3. Spot the early signs. When you start to feel that your credit card debt appears to be very high, try to curb your expenses and pay the outstanding bills first before making any new purchase on credit.
4. Read the terms mentioned on your credit card kit carefully before you start borrowing. A credit card is nothing more than a card that allows you to borrow money. So, you must know what all you stand to lose if repayment is delayed – interest, late fee, penalty, etc.
One should make sure that your entire credit card limit is not exhausted. And if your credit card expenses are likely to shoot up, try to request the bank to raise the limit of your credit card. This will help you maintain a healthy credit rating. Also, make sure not to delay the payments – as late fees and interest will keep piling up.
