How Credit Cards Impact Your Credit Score
In India, the growth in credit card issuance has intensified and it has gained acceptance across different geographies and segments of people. With a plethora of rewards available, it is difficult to picture our life without a credit card. The financial flexibility of buy now, pay later and credit equated monthly instalments (EMIs) has further increased the “cashless” trend. A credit card is nothing more than a short-term loan, with a predetermined credit limit, agreed upon both by the customer and the issuing bank. The credit limit on your card is the maximum amount you can spend. Every time you make a purchase or pay a bill, your card gets charged and the credit limit is reduced. At the end of the billing cycle, you must repay what you have spent.
The benefits that a credit card offers today are innumerable. While the convenience of “buy now and pay later” plus easy EMIs are primary benefits, credit cards also provide a slew of offers ranging from e-commerce to food-tech companies. These changes every month give users something new to look forward to and allow them to make the most of what is out there.
Benefits of Owning a Credit Card
Owning a credit card makes life easy, simplifies purchases and payments by offering the following benefits:
Convenience and safety
Credit cards can be used to make bills and other payments in addition to making purchases. They are also accepted by all types of merchant categories and payment modes, be it physical or online. It can be used to pay for anything anywhere, by simply swiping the card, without the need to carry cash around.
It is also a beneficial payment instrument when traveling in a foreign country. It reduces the dependency on cash and you can travel stress-free about losing your money or having your pocket picked. So, from hotels to flights, dinners to shopping, a credit card can handle it all anywhere, in a highly secure and seamless manner.
Credit cards offer flexibility when it comes to repayment of the dues at the end of every month. The payment can be done using any of the available payment options, like cash, cheque or online. For people who want to make big purchases while not wanting to make a dent to their savings, EMI options are also available.
Incentives and offers
Many credit card companies provide a variety of advantageous offers and incentives. The benefits are numerous, ranging from accumulating reward points to cash backs that can later be redeemed for additional offers. Cards also provide discounts on purchases made for tickets, vacations, or large purchases, allowing you to save money.
How to Use Your Credit Cards Effectively
There are many reasons to use credit cards but the way you use your card has an impact on your credit score which determines your creditworthiness. Credit scores are used by lenders before deciding to give you a loan and also determine if you are eligible for preferential interest rates.
In order to maintain a good score, always ensure that no matter what credit product you have, you adopt a disciplined repayment plan and be wise with the usage of your credit limit. Keep these factors in mind when you use your credit card to ensure a healthy credit score.
Payment of credit card dues
To maintain a healthy credit score, it is advisable to make timely payments. At the end of every month, you have two options of repaying your credit card dues; total outstanding amount and minimum amount. It is advisable to repay the full amount before the due date. However, if you choose to clear the “minimum amount due”, it will reduce the outstanding balance of the current month but will not lower the total debt (outstanding amount).Depending on your card, you will be charged from 3% to 4% interest per month. In case of minimum due payment, a large chunk of the outstanding amount remains unpaid at the end of the credit free period. On an annualised basis, the interest rate can go up to 30% to 50% a year.
To avoid getting into this debt trap and ensuring a healthy credit score, you should always make the credit card payments in full within the stipulated due date. Alternately, if you have to opt for the ‘minimum amount due’, then it is advisable to pay the balance dues within the next month in full.
Credit utilisation ratio
Credit utilisation ratio is the amount of money you spend versus the credit limit you have, represented as a percentage. A low credit utilisation ratio implies that you are not overspending and capable of managing your finances in a better way. Additionally, it also has a positive impact on your credit score.
Period of holding your credit card
The length of your credit card history is one of the factors that can affect your credit score. A card that you have been using for a few years versus a card that is a few months old, will have more insights in your spending pattern and is valuable to your credit score. It is therefore advisable to retain your long standing credit cards and ensure you clear the dues on them in a systematic manner.
Number of credit cards in your name
To increase the spending limits and reduce the credit utilization ratio, people tend to own multiple credit cards. However, it may become difficult to track these multiple card payments, which may lead to payment defaults, thus impacting credit score negatively. It is best to have a limited number of credit cards and be disciplined in their repayments.
Basic Tips to Manage Your Credit Card
To ensure that you do not get debt-ridden due to mismanagement of your credit cards, keep these simple tips in mind:
Be aware of your credit card’s terms and conditions and limit your usage accordingly.
Do not spend more than you can pay back and keep spending within the credit limit, always.
Avoid impulse buying and use your credit card for planned purchases only.
Ensure to pay your credit card bills in full to avoid hefty charges and penalties.
Staying observant with your life and money goals can lead to an enhanced self-esteem. Disciplined usage and management of credit cards will help you build a healthy credit score which in turn will ensure fulfilment of your life goals and long-term financial stability.
Navin Chandani, MD & CEO, CRIF Highmark