Credit Cards - Merits & Demerits

 

During my CA article training (mid to late 1980s), when auditing the accounts of some clients I had opportunities to see some credit card statements. This was the first time I was hearing about and seeing a credit card statement. This was a new financial instrument for me.

What I learnt about credit cards then & subsequently over the past 3 decades is that it is a debt instrument which offers credit facility up to a specific pre-set limit. This allows you to use the credit facility immediately and pay for it later. The use could be purchasing products, services and in certain cases withdrawal of cash. One needs to have a good credit history to be able to procure a credit card.

My own personal experience in applying for a credit card is quite interesting. My first two applications for a new credit card were rejected. I realized that (in 1990s) to obtain a credit card you need to fulfil some stringent criteria.

However, thanks to my alma mater - the Institute of Chartered Accountants of India (ICAI). In one of the monthly CA Journal, I saw an application form for credit card from a leading foreign bank, applied for one and got my first credit card with a limit of INR 10,000. After an uncle of mine who was working in a PSU Bank, I was probably the second person in our family to be issued a credit card. Since then, our family has applied for several cards. We are now using atleast a dozen cards, each for a different purpose.

 

Our experience of using credit cards over the past 30 / 35 years made us realise that credit cards come with a myriad of advantages and disadvantages. Understanding these aspects is crucial for responsible financial management.

Some of the common advantages are:

Credit cards offer Convenience. They eliminate the need to carry large sums of cash, providing a secure and widely accepted method of payment. This convenience is especially apparent in online transactions and during travel.

 

By using a credit card responsibly one can build and establish a good credit history. A positive credit history is essential for obtaining favorable interest rates on loans, mortgages, and even influencing employment opportunities.

Most credit cards come with rewards programs, offering cash back, travel miles, or points for every purchase. Savvy users can leverage these programs to receive discounts or freebies, effectively making their spending work for them.

 

Credit cards can serve as a financial safety net during emergencies or unexpected expenses. They provide immediate access to funds, allowing individuals to address urgent needs even when their liquid cash may be limited.

Credit cards often provide additional protection for purchases. This may include extended warranties, insurance against theft or damage, and the ability to dispute unauthorized transactions, offering consumers a layer of security when making significant purchases.

However, if used indiscriminately, they can land one into a financial mess.

Some of the common disadvantages are:

Credit cards use may lead to debt accumulation. The ease of swiping a card can lead to impulsive spending, and if not managed carefully, this can result in a cycle of debt that becomes challenging to break.

 

Credit cards typically carry higher interest rates compared to other forms of debt, such as loans or mortgages. If users carry a balance from month to month, they can incur substantial interest charges, significantly adding to the overall cost of purchases.

Credit cards often come with various fees, including annual fees, late payment fees, and cash advance fees. These fees can erode the benefits of using a credit card, especially if the cardholder is not diligent about understanding and avoiding them.

 

The accessibility of credit can lead to a temptation to overspend. The disconnect between the physical exchange of cash and the seemingly abstract nature of card transactions can make it easier for individuals to exceed their budgetary limits.

While responsible credit card use can positively impact a credit score, mismanagement can have severe consequences. Late payments and a high credit utilization ratio can all contribute to a decline in creditworthiness.

 

To sum up, credit cards are powerful financial tools that offer both advantages and disadvantages. To get maximum benefits, users must exercise discipline, budgetary control, and a thorough understanding of the terms and conditions associated with their cards. Responsible credit card usage involves paying balances in full, avoiding unnecessary fees, and leveraging rewards programs without falling into the trap of debt accumulation. By being mindful of the potential pitfalls, individuals can make informed decisions that align with their financial goals. It's therefore crucial to use credit cards responsibly to maximize benefits and minimize risks.

 

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