How to Use a Credit Card

Credit cards are powerful tools that can make your everyday life easy and profitable. However, credit cards can put you in a tough financial position, if not used correctly. Therefore, if you are planning to apply for a credit card, it would be in your best interest to read this guide to learn more about proper credit card usage.

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How to Use Your Credit Card

Credit cards are easy to apply for, but once you have one it is important to be cautious with your spending. Cardholders must ensure that they take all the necessary steps to successfully reap the rewards without accruing debt. It is imperative that you pay your bills on time and in full, this is the only way to avoid the high interest that is charged by the banks in India (average of 41%). This interest rate is applied to your outstanding balance, which means that your debt can accrue quickly. Once you fall into credit card debt, it can be difficult to get out. This is because the larger your outstanding balance, the more you will have to pay for your minimum payment. Therefore, you can easily fall into a cycle of payments that will eventually be out of reach for you. Once the balance and payments exceed what consumers can afford to pay each month they end up playing catch up while the minimum continuously accumulates interest.

Keep Track of Time

The first rule of getting a credit card is that time management is key. To successfully pay off your bills you should be aware of the payment due date and set up reminders to ensure that you pay the minimum on time (at the very least). In addition to the interest costs highlighted in the paragraph above, if your payment dates and end up paying late fees. Further, as the late fees add up, your CIBIL (Credit Investigation Bureau India Limited) score begins to drop. This makes it harder for you to apply for loans, insurance or other credit cards in the future. Following this rule of time management will help you stay out of debt and help you manage a good CIBIL score.

If you are just starting out with a credit card, there are a number of ways you can help remind yourself to pay your credit card bills on time. One way is to set a reminder on your calendar or some sort of alert system every month. The banks usually have a system like this set in place but it can be useful to do one for yourself. Additionally, it is important to never charge more than what you can afford on the credit card. This way you will not be over-spending and biting off more than you can chew financially.

Know Your Card's Billing Cycle

Every credit card has a billing cycle that cardholders should be aware of. You will receive a statement each month that will have two dates—the statement date (closing) and the payment date. The statement date indicated the final date that charges will be placed on that month's statement and the payment date is the date the payment for the month is due for the provided statement.

For instance, you might have a closing date on the 25th of each month and a payment date on the 15th. In this case, your October statement would run from 25th September to 25th October with a payment due on November 15th. Card issuers in India allow for a grace period where interest is not charged as long as the bill is paid off during that time, this can range from 20 to 50 days. Cards are unique in terms of their billing cycle, statement date and grace period. As a result, you should always review the information for your credit card to fully understand where you stand and how to stay on top of your payments. The more credit cards you manage the more diligent you have to be.

Paying Off Your Bill

When managing your credit cards it is critical that you, not only pay your bills regularly, but to pay off your bills entirely. Many cardholders may pay off their credit cards on-time, but forget to pay off the balance in full. By doing this they are risking tens of thousands of rupees to interest payments and lower CIBIL scores. Paying only part of your balance (or even the minimum payment) is referred to as "rolling over" your balance. By rolling over your payments, you are actually incurring more interest. The average credit card in India charges an APR (annual percentage rate) of 41.36%. This high rate will continue to accumulate on the cardholders balance and can make it extremely difficult to get out of debt. Just because you are paying the minimum off does not mean you are escaping the interest rate, the interest is being charged until the entire balance for the statement is paid off.

Interest can be charged for the following scenarios:

  • When you fail to pay the outstanding balance by the due date.
  • When you only pay the minimum amount due.
  • When you pay less than the minimum amount due.

For example, imagine that you spent Rs. 5,000 on your credit card and made a payment of just Rs. 1,000 by the payment date, with the plan of paying off 1,000 per month. Your card will then accrue interest based on the Rs. 4,000 remaining—we will assume that it will accrue interest at a rate of 3.33% monthly (40% p.a.), which results in Rs. 133.32 of interest in your first month. This gets compounded, furthering your debt position. the following payment date, due to interest. Therefore, by the end of paying off the entire card, you would have accrued Rs. 2,382 in interest alone. Further, all charges made on that card from then on will accrue interest until the full statement is paid off. However, if you happen to pay off the minimum amount due, then interest is charged on the balance remaining on the previous months statement and on all new transactions till the previous balance is completely paid off will also accrue interest. Therefore, It is absolutely imperative that you meet your minimum payment, and crucial to your credit card bills off entirely each month.

Stay in Control of Your Balances

Something that many consumers overlook is the credit utilisation ratio. The credit utilisation ratio is the amount of credit used on the card in proportion to the credit limit that is available. The consensus among experts is that your credit utilisation ratio should not exceed 30%. For instance, if you have a Rs. 100,000 credit card limit, you should try to remain in the Rs. 30,000 region for spending. Using over 50% of your credit limit can hurt your overall CIBIL score, which can lead lenders to believe that you are a high risk client.

Monitor Your Account Balance

Although you may feel confident that everything is paid off and that you have control over your spending, it is important that you are diligent and continue to check your monthly balance. This will help you best monitor your statement, make sure there is no irregular activity and ensure that your account has no fraud. Banks usually have systems in place to track and monitor fraud, but it is always good to check and see if there are any charges you do not recognize. Therefore, you should check your account on a monthly basis as a way to be sure you are on track with your financial goals and for the security of your account.

Spend Only What You Can Afford

When using credit cards, many individuals misuse the power of not having to immediately pay off their balance, and spend more than they can actually pay off. Mistakes and overspending can lead to credit card debt. The best way to limit over spending is to aim to spend only what you have in your checking account and try to not go over that limit. As stated above, it is best to spend what you can pay off in-full. As tempting as it may be to spend money that you will have in the future, you never know what emergencies may occur that would make it difficult for you to pay off your balance.

Building Credit With a Credit Card

Credit Cards are a great way to build credit, and by following the guidelines and rules we discussed above, you will be on track to building a great CIBIL score. As someone looking to build credit, it is important to understand how CIBIL scores are calculated and how they are affected by credit cards.

How the CIBIL Score is Calculated

The CIBIL Score is calculated using key components that are related to credit cards, they are the following:

  • Length of Credit History: The longer your credit history the more your credit profile will be trusted in the future when applying for home or auto loans.
  • Credit Utilisation Ratio: The amount of credit used divided by available credit. The recommended ratio is under 30%. Additionally, going over 30% may make it difficult to pay it all off. Taking up too much available credit can also reduce your score.
  • Outstanding Debt: Not paying off your outstanding debts negatively impacts your CIBIL score.
  • Applying to Multiple Credit Applications: Having multiple credit applications and credit inquiries run at the same time can make it seem like you are desperate for credit options, thus having a negative impact on your CIBIL score. If a loan or credit card application has been recently rejected, try to improve your score before applying to another credit financial product.
  • Credit Mix: A good credit mix with multiple forms of credit (e.g. credit cards, loans, etc.) generally helps your score.

Using Credit Cards to Build Your Score

As previously stated, credit cards are great for building your credit score. Keeping track of your payment history and credit utilisation will help you build your score and keep it as high as possible. After monitoring your payment history and making sure that there are no issues with the charges, you can make the best decisions with how much more to spend on your card. This will also help you monitor your payment date. Additionally, by keeping track of your credit utilisation, you will be aware of how much you are spending and whether you're spending excessively for the month. There are some other factors that can help build a good credit score as well, such as:

  • Irresponsible Payment Behaviour: When the cardholder is spending more than they can afford to spend it becomes problematic in the long-run and ends up hurting their score. The cardholder incurs more interest over time and gets stuck in a debt trap.
  • Outstanding Debt: It is crucial to pay off all your debts fully to avoid interest, not paying off your outstanding debts negatively impacts your CIBIL score.
  • Paying Minimum Amount Due: Paying the bare minimum required per month may put you into a debt trap and will accumulate interest until the full balance is paid off, resulting in a lower score.
  • Closing Old Credit Card Accounts: If you are not actively paying an annual fee or if it is not costing you anything, do not close old credit card accounts. An older credit account usually helps.

How to Use a Credit Card to Earn Rewards

This may be the primary reason why you are on this page, to learn about credit card rewards and how to maximise the value of your spending. To maximise your spending, you will have to reflect on your own spending and try categorising yourself as a spender. After determining the type of spender you are, you can pick a card.

Reflect and Analyse Your Own Spending

To make the most informed decision when picking a credit card, you need to be aware of all the options that are available. What categories do you end up spending most of your money on? After finding out the categories your spending is heavily geared towards you can start researching the different types of credit cards that you should apply for. Many options will offer elevated rewards on the spending categories that you spend more in or may offer certain perks that can help reduce your overall annual expenses. This exercise will help you narrow down to a few cards that will be most suitable. Whether you get one or more cards, try to make sure you don't overspend and always read the fine print.

Cashback vs Miles

Once you really start to narrow the cards down by categorising yourself as a spender, you will then decide on the type of rewards you want to earn. You can choose between cashback cards, which offers cashback on spending or miles cards, which offers travel rewards on spending.

There are a good number of differences between both cards. Cashback is the most flexible rewards system that can be applied to anything. It is extremely liquid and easy to use. Cashback cards usually have a lower cap than other credit card types. Travel rewards cards offer elevated rewards on travel and great travel-centric benefits. The cards also have higher caps, if any, on their rewards. Some cards are known for being linked to specific travel providers. A major difference is that cashback cards do well for consumers across the board as they have solid rewards for more categories, whereas the travel rewards cards have very high rewards for fewer categories.

Sahmi Chowdhury

Sahmi is a Junior Research Analyst specialising in credit cards and insurance in India. He previously worked in the financial services sector at Brown Brothers Harriman and True Capital Management.