Credit Cards, Advantages, Disadvantages and Its Basic Jargons
what is credit card?
A credit card is essentially a financial tool that allows you to access a line of credit immediately, which is like a predetermined amount of money that a bank or credit card company is willing to lend you. This amount is known as your credit limit. It’s like having a financial safety net that you can tap into when you need to make purchases or pay for services.
When you use a credit card, you’re essentially borrowing money from the bank, with the promise that you’ll pay it back later within a period of 45-50 days or 15 days from the date of bill generation . It’s a bit like a short-term loan. For instance, if you use your card to buy a new Iphone 15, you’re not actually using your own money at that moment. Instead, you’re using the bank’s money, and they trust you to repay it.
Now, here’s where it gets interesting. Typically, you have a billing cycle, usually a month, during which you can make multiple transactions using your credit card. At the end of this cycle, the bank compiles a statement that lists all your transactions during that period.
You then have a choice to either pay off the entire amount shown on the statement, which is called the full balance, or you can choose to pay a smaller portion, which is often referred to as the minimum Amount Due. However, if you opt for the minimum payment, keep in mind that the remaining balance will accrue interest which ranges between 2.75 p.m – 3.6 p.m or 30% – 44% annually . This is essentially the cost of borrowing the money.
Interest rates can vary, so it’s crucial to understand the terms of your specific credit card agreement. Some credit cards offer promotional periods with low or zero interest rates for a set period, which can be advantageous.
Furthermore, credit cards often come with additional perks and benefits. These can include rewards programs that allow you to earn points or cash back on your purchases which varies from banks to banks and also the card you own. Some cards also offer travel benefits, such as free travel insurance or access to airport lounges.
Remember, while credit cards offer convenience and various advantages, it’s crucial to use them responsibly. Accumulating a large balance without a plan to pay it off can lead to financial stress and negatively impact your credit score. So, always strive to maintain a balance between using your credit card for convenience and managing your finances responsibly.
Commonly used Credit Card Jargons
Credit Limit
Think of your credit limit as a spending safety net provided by your credit card company. It’s like having a cap on how much you can use your credit card. For example, if your credit limit is ₹50,000, imagine it as a budget just for your card.
Let’s say you go shopping and make purchases totaling ₹30,000 using your credit card. Since your credit limit is ₹50,000, you still have ₹20,000 available for further spending. It’s important to remember that going over this limit can lead to extra charges or declined transactions.
So, your credit limit acts like a financial guardrail, helping you manage your spending within a set boundary. Keep an eye on it to ensure you’re making purchases within your approved limit!
Annual Fee
Think of the annual fee as a membership fee you pay to have a particular credit card. It’s like being a member of a club that offers special perks and benefits along with the membership.
For instance, imagine you have a premium credit card that comes with an annual fee of ₹2,000. This fee is what allows you to access extra advantages like travel insurance, exclusive discounts, lounge access, golf club memberships and rewards programs.
It’s similar to joining a gym where you pay a yearly fee to use their facilities and enjoy additional services like personal training or fitness classes. In the same way, the annual fee gives you access to enhanced features and benefits associated with your credit card.
Remember, not all credit cards have an annual fee, and it’s important to weigh the benefits and consider a cost benefit analysis.
Annual Percentage Rate
APR, or Annual Percentage Rate (a.k.a. Interest rate), is a standardized way of expressing the cost of borrowing money or the yield on an investment over a yearly time frame. It includes the interest rate as well as any additional fees or costs associated with the loan or investment.
For instance, suppose you have a balance of ₹10,000 on your credit card at the end of the month. With an APR of 35%, over the course of a year, you would be charged ₹3,500 in interest on top of the ₹10,000 you owe.
So, if you didn’t pay off your balance and left it at ₹10,000 for a year, you’d end up owing a total of ₹13,500 due to the 35% APR.
It’s important to remember that Annual Percentage Rate can significantly impact the overall cost of borrowing on a credit card, so it’s always wise to try and pay off your balance in full each month to avoid these extra charges.
Credit Score
Your credit score is like a report card for your financial responsibility. It’s a three-digit number that helps lenders understand how reliable you are at repaying borrowed money. Think of it as a grade that tells them how trustworthy you are with credit.
When you were in school and you get grades like A, B, or C for your performance. Your credit score is similar, but it ranges from 300 to 900. The higher your score, the better. It’s calculated based on various factors like your payment history, how much you owe, credit utilization ratio, the length of your credit history, and more.
Credit scores typically range from 300 to 900. The higher your score, the better. Here’s a breakdown:
- 300 – 499: Fair
- 500 – 649: Good
- 650 – 749: Very Good
- 750 – 900: Excellent
Let’s say you have a credit score of 780. This is considered excellent. It tells lenders that you’re very dependable when it comes to managing credit. They’re more likely to offer you better terms, like lower interest rates or higher credit limits.
On the other hand, if your score is 450, it’s not as good. This might signal to lenders that you’ve had some difficulties managing credit in the past. They might be more cautious and may offer higher interest rates or lower credit limits.
So, your credit score is like a reputation scorecard for your financial behavior. The higher it is, the more options and advantages you’ll have when it comes to borrowing money. It’s always a good idea to keep an eye on your credit score and work towards maintaining or improving it.
There are four credit bureaus in India:
These credit bureaus collect and maintain information about your credit history, such as your loan accounts, credit card accounts, and repayment behavior. They use this information to calculate your credit score, which is a three-digit number that lenders use to assess your creditworthiness.
Billing Cycle
The billing cycle is the period of time, typically a month, that starts on a specific date (like the 1st of the month) and ends on another (say, the 30th or 31st).
Imagine the billing cycle as a specific time frame during which all your credit card transactions are recorded. It’s like a little window that captures everything you do with your card.
Example:
Let’s say your billing cycle starts on the 1st of every month. This means that from the 1st to the last day of that month, all your card transactions are noted down. So, if you buy groceries on the 5th, go out for dinner on the 10th, and make an online purchase on the 20th, all these transactions fall within that billing cycle.
At the end of the cycle, the credit card company puts together a statement that includes all these transactions. This statement shows you the total amount you’ve spent, any payments you’ve made, and the remaining balance.
Remember, the billing cycle helps you keep track of your spending and understand your financial habits. Keep an eye on it to stay on top of your credit card usage.
Due Date
The due date is like a deadline for paying your credit card bill. It’s the specific day each month when your payment is expected to reach your credit card company. Usually its 15 -20 days after the bill is generated.
Imagine it as a friendly reminder from your credit card company, saying, “Hey, it’s time to settle up for the purchases you made.“
Example:
Let’s say your credit card’s billing cycle ends on the 5th of each month. This means that all the transactions you made from the 6th of the previous month to the 5th of the current month will be included in your statement.
Now, your due date might be set for the 25th of each month. This gives you about 20 days to review your statement and make your payment. If you don’t pay at least the minimum amount due by the 25th, you may be charged a late fee, taxes and many more surprise charges by the bank/ credit card issuer.
For instance, if your total statement balance is ₹5,000, and the minimum amount due is ₹500, you must make a payment of at least ₹500 by the due date to avoid any extra charges.
Grace period
The grace period is the time you have after getting your bill to pay without any extra charges. It usually lasts between 14 to 21 days, depending on your provider. The great thing is, during this time, you won’t be charged any interest on what you owe. This is really important to remember when using a credit card because it gives you some breathing room to manage your payments without extra costs. So, it’s like a helpful buffer that keeps you from getting hit with extra fees.
Minimum Amount Due
Think of the Minimum Amount Due as the smallest payment you’re required to make on your credit card bill each month to keep your account in good standing (Avoid late Fee).
For instance, imagine you received a credit card statement showing a total balance of ₹5,000. Among this, the Minimum Amount Due is ₹500. This means, to meet your obligation and avoid any late fees or negative impact on your credit history, you need to pay at least ₹500 by the due date.
Now, let’s say you can’t pay off the full ₹5,000 balance at once. By paying the Minimum Amount Due, you’re essentially meeting the baseline requirement set by the credit card company. However, keep in mind that the remaining ₹4,500 will continue to accrue interest until it’s paid off in full.
It’s crucial to note that while paying the Minimum Amount Due keeps your account in good standing, it’s always recommended to pay more than the minimum whenever possible. This helps you reduce interest charges and pay off your balance sooner.
Rewards
Credit card rewards are points, miles, or cashback that you earn when you use your credit card for purchases. These rewards can be redeemed for various benefits like cash back, travel discounts, gift cards, or merchandise.
Example:
Let’s say you have a rewards credit card. Every time you use it to make a purchase, you earn points. For instance, you might earn 1 point for every ₹100 you spend.
Once you’ve collected enough points, you can redeem them for something you like. This could be cash back on your statement, a gift card to your favorite store, or even a plane ticket for your next vacation!
Over Limit Charges
When you surpass your credit limit by making purchases or withdrawals, you might incur over-limit charges. These charges can vary depending on your credit card issuer and terms.
Example:
Imagine your credit limit is ₹50,000. You’ve been using your card for various expenses and haven’t kept a close eye on your balance. One day, you make a purchase that pushes your balance to ₹51,000. This means you’ve exceeded your credit limit by ₹1,000.
Shortly after, you receive your credit card statement with an over-limit charge of, let’s say, ₹500. This charge is a reminder that you went over your set spending limit.
A better way to avoid over limit charges are setting spend limit on your card. You can easily use the mobile app or website of your credit card issuer
Cash Advance
A cash advance is like borrowing money directly from your credit card issuer. It’s a way to get cash in hand when you need it, but it comes with some costs and considerations.
Definition:
Imagine you’re in a situation where you need cash urgently, but you don’t have any on hand. A cash advance allows you to use your credit card at an ATM or a bank to withdraw cash, just like you would with a debit card.
Example:
Let’s say you’re on a road trip and you run into a situation where you need cash for an unexpected expense, like a car repair. If you use your credit card to withdraw ₹5,000 from an ATM, this transaction is considered a cash advance.
However, it’s important to note that cash advances usually come with extra fees and higher interest rates from the date of withdrawal compared to regular credit card purchases. So, while it’s a convenient option in emergencies, it’s generally advisable to use it sparingly and be aware of the associated costs.
Balance Transfer
Balance transfer is the process of moving the amount you owe on one credit card to another card, usually with the goal of getting a better deal on interest rates.
Imagine balance transfer as a financial “switch” you can use to move debt from one credit card to another. It’s like shifting a loan from a bank with high interest to one with lower interest rates.
Example:
Let’s say you have a credit card (Card A) with a ₹20,000 balance and an interest rate of 18%. Another credit card company offers you a deal to transfer this balance to their card (Card B) with a lower interest rate of 12%.
If you decide to go ahead with the balance transfer, the ₹20,000 debt from Card A will be moved to Card B. This means you’ll now owe ₹20,000 to Card B instead. Because Card B has a lower interest rate, you’ll end up paying less interest over time.
Keep in mind that balance transfers may come with their own terms and conditions, including fees for the transfer. Always be sure to understand these terms before making a balance transfer.
So, think of balance transfer as a smart financial move to potentially save money on interest payments when you have existing credit card debt. It’s like finding a better deal on a loan to help you manage your finances more effectively!
How credit cards work?
When you use a credit card to make a purchase, the merchant sends a request to your credit card issuer for authorization. The issuer then checks your account balance and credit limit to make sure that you have enough available credit to cover the transaction. If you do, the issuer approves the transaction and the merchant is paid.
You will then receive a monthly statement from your credit card issuer that shows all of the transactions that you made during the previous month. You must pay at least the minimum payment due on your statement by the due date in order to avoid late fees and interest charges. If you pay the full balance of your statement each month, you will not be charged any interest.
Here is a short explainer video on how do credit cards work?
Benefits of using credit cards
Credit cards offer a number of benefits, including:
- Convenience: It’s a convenient and easy way to pay for goods and services. You can use them anywhere that accepts cards, both online and in stores.
- Rewards: Many cards offer rewards programs that allow you to earn points or miles on your purchases. You can then redeem these rewards for travel, merchandise, statement credits, and more.
- Credit building: Using a credit card responsibly and paying your bill on time can help you to build good credit. This can lead to lower interest rates on loans and mortgages in the future.
Drawbacks of using credit cards
There are also some potential drawbacks to using credit cards, including:
- Interest charges: If you carry a balance on your credit card from month to month, you will be charged interests on monthly basis roughly around 3.5%. Interest rates can be high, so it is important to pay off your balance in full each month if possible.
- Annual fees: Some cards charge an annual fee. This fee can range from as low as hundred rupees to a fifty thousand rupees or more.
- Overspending: It can be easy to overspend, especially if you are not careful. This is because you are not spending your own cash, but rather borrowed money.
How to use credit cards responsibly?
If you choose to use credit cards, it is important to use them responsibly. Here are a few tips:
- Pay your bill in full and on time each month. This will help you avoid paying interest and damage to your credit score. If you can’t afford to pay your entire balance in full, pay more than the minimum payment.
- Keep your credit utilization ratio low. Your credit utilization ratio is the amount of credit you’re using divided by your total available credit. It’s best to keep your utilization ratio below 30%.
- Only use your credit card for things you can afford. Don’t use your card to finance impulse purchases or live beyond your means.
- Shop around for the best card for your needs. There are many different cards available, with different features and interest rates. Compare cards to find the one that’s right for you.
- Be aware of the fees associated with your credit card. Some cards charge annual fees, foreign transaction fees, and other fees. Be sure to read the fine print before you apply for a card.
Here are some additional tips for using credit cards responsibly:
- Set a budget and track your spending. This will help you stay on top of your finances and avoid overspending.
- Only use for necessary expenses. This could include things like groceries, gas, and utilities.
- Beware of cash advances. Cash advances typically have high interest rates and fees.
- Be careful while making online purchases. Make sure you’re shopping at a reputable website and that your card information is secure.
- Review your credit report regularly. This will help you catch any errors or suspicious activity on your account.
By following these tips, you can use credit cards responsibly and build a good credit history.
FAQ's
Credit cards allow you to borrow money up to a certain limit to make purchases, and you must repay the borrowed amount along with any interest within a specified period.
The ideal number of credit cards varies for each individual. It’s recommended to have a manageable number that you can use responsibly and keep track of effectively.
Credit cards function by allowing you to make purchases on credit. You’re required to repay the borrowed amount, usually on a monthly basis, and there might be interest charges if you don’t pay the full balance.
Several premium credit cards offer lounge access as a perk. Some popular ones include American Express Platinum, Chase Sapphire Reserve, and Priority Pass affiliated cards.
The four main types of credit cards are:
- Standard Credit Cards
- Rewards Credit Cards
- Secured/ FD backed Credit Cards
- Charge Cards / Prepaid Cards
The State Bank of India (SBI) offers a range of credit cards, each designed to cater to different needs. Overall there are around 20 different types of SBI credit cards.
To use credit cards responsibly, only purchase what you can afford to pay off each month, set a budget, track your spending, pay your bill on time and in full, and be aware of the fees associated with your credit card.
The Minimum Amount Due is the smallest payment you’re required to make on your credit card bill each month to keep your account in good standing and avoid late fees.
A balance transfer is the process of moving the amount you owe on one credit card to another card, usually with the goal of getting a better deal on interest rates.
Thanks for the detailed information
Very Detailed article Thank you
Impressive and awesome article
Thank you . Please post more
Extremely helpful Sir. Thanks
I want to close 2 out 6 of my credit card due to high fees. would it affect my credit score?
Yes It would affect your credit score depending on the age of the credit card.
Very detailed post
Totally enjoyed reading
Good article sir
Can I join your team
Sir I just pay min due every month will there be issues? Please help
If I pay minimum due then its fine right.
I really enjoyed reading it. It helped me a lot and I hope it will help others too.
Very well explained sir. As a student i understood it
Can I ask a doubt
Sure please feel free to ask any doubts
Sure Please comment your doubt
Can't Thank You Enough Sir.
For investments in ELSS MFs via SIP, an investor will not be able to redeem MF units purchased in any given month until 3 years from the date of purchase of said MF unit, correct?
Yes, each SIP will have a lock in for 3 years.
Do investments made via SIP in ELSS MFs also qualify for 80C exemptions or will they be applicable only if I invest in lumpsum?
Yes, SIPs also count and not just lumpsum
Can you please explain how the compounding effect is applied in MF investments through SIP..
Very detailed explanation. Thank You
Wow. Thank You Sir making it so easy to understand.
Wow . . . 😍
Just great content
Oh man credit card is such a trap but you clarified it smoothly
Thank you for providing me with these article examples. May I ask you a question?
Wish read your article before falling for the minimum due trap
Maza aa gaya sir. Apne bahut kuch clear kar diya. Thank you
You Cleared a Lot of my doubts. Thank you sir
Thanks for posting. I really enjoyed reading it, especially because it addressed my problem. It helped me a lot and I hope it will help others too.