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Are you one of the people trapped in credit card benefits like cashback, e-vouchers, and reward points?
But are they really beneficial or hooks that can land you in a trap?
If you use your credit card with care and abide by the essential rules of using a Credit Card, you will improve your credit score.
Whereas, if you don’t follow these rules Credit Card could literally create havoc in your financial life; not only your credit score will go down but your credit card will keep you in a debt trap!
It’s important to educate yourself about these credit card traps before falling into any of them.
Let’s get started with knowing the 9 Credit Card Traps that’ll Destroy Your Credit Score.
Table of Contents
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1. Debt Trap
2. The trap of ‘Minimum Balance’
3. The trap of the utilization of maximum Credit Limit
4. The trap of having more number of Credit Cards
5. The trap of 0% EMIs
6. The trap of Cash Withdrawal from Credit Cards
7. The trap of offers on credit cards
8. The trap of multiple fees
9. The trap of sinking into a bad credit score
5 Ways to Avoid the Credit Card DebtTrap
9 Credit Card traps you must avoid
1. Debt Trap
You can surely use the credit card, but you have to pay it back in full, ON TIME. And, in case of any delay after 50 days duration, there is a heavy penalty in the form of 24%-36% interest p.a.!
Higher credit limits and other benefits in Credit cards have the potential to make you spendthrift. You will always have the belief of paying back all your credit card dues on time.
But paying the entire monthly bill upfront is not possible most of the time for most people!
As a result, you will slowly drift into the debt trap without consciously knowing about it!
Even worse, your credit score will go down with time. And, ultimately it will harm your financial life. We will discuss the credit score later in this article.
Also, your Credit Card Company will provide you with the exciting option of paying your dues through “Minimum Balance”, which itself is a huge trap of getting you under debt! We will discuss this in the next section.
2. The trap of ‘Minimum Balance’
If your credit card due is Rs. 63,000; Credit Card Company will offer you to pay around Rs. 1600 every month. It may seem irresistible to pay the minimum balance instead of the full amount, but the problem with this facility is that the interest will be levied from the day-1 of your first credit card spent on that particular month, and there won’t be 30-50 days of the interest-free period.
And, the interest will be in the range of 24%-36% p.a., which keeps accumulating in your total debt.
You choose to pay just the minimum balance and your debt will keep growing exponentially over the months and years. You may feel that Credit Card Company is over-charging you but that is not the case! It’s just a trap of Minimum Balance, which you have to avoid.
3. The trap of the utilization of maximum Credit Limit
You should not utilize all your Credit Limit.
Let us say if your credit card limit is Rs. 2,50,000 and if you end up using Rs. 2,00,000 or Rs. 2,25,000 each month, which will affect your credit score in a BAD way.
You might be managing your credit limit effectively and paying all your dues ON TIME. But your bank will perceive that your life is dependent on the credit card and it is viewed negatively.
Therefore, stop reaching 80% or 90% of your credit limit. However, you can utilize around 30%-40% of the credit, it is well accepted and viewed positively. With this credit limit, you can easily spend Rs. 1,00,00 per month, this will keep your credit scores high.
Practice the 30% thumb rule of spending credit for all your credit cards.
Now, how many credit cards you should have? Well, this is an important topic and it is discussed in the next section.
4. The trap of having more number of Credit Cards
Having so many credit cards is not recommended. Why?
Because you have to worry about their maintenance and you are required to keep track of most of their bills; if you miss paying the bills on time, you will be charged heavy interest and penalty.
So, stop and think: do you need multiple credit cards?
The more credit cards you have, the more will be the maintenance issues, their annual charges and the more chance of you forgetting their bills and hence, getting deeper into debt. And, as a result, the lower will be your credit score.
Therefore, the rule is to keep the number of credit cards based on your personal needs.
- If you are a frequent traveler, you may want to keep an airline-specific credit card, which gives you good offers on air-travel and airport lounge access.
- If you do online shopping frequently, you can use the cash back credit cards or the credit card affiliated with Amazon or another online shopping platform.
This way you can limit your credit card to a maximum of 2-3, which you really need and can easily maintain and can pay their bills on time.
5. The trap of 0% EMIs
Some credit card companies may lure you to buy expensive products at 0% EMI. In fact, 0% EMI has become a driving force behind many of the big purchase decisions nowadays.
But, do you know that the 0% EMI was banned by the Reserve Bank of India (RBI), in 2013? In its circular dated September 17, 2013, stated that the very concept of zero per cent interest is non-existent.
How do these schemes still work then? How do some banks still throw that offer?
Well, the interest cost is in some ways passed on to the customers either in the form of processing fees or in the form of denying offers and discounts. If you pay cash up front, you get a better negotiation power and a better deal.
The main business of Banks or any other financial institution is to give loans and earn interest. Interest is their bread and butter. Will they forego their income? They won’t. The name of the interest may change, but its effect doesn’t.
Therefore, there is no free EMI, it’s just another trap to make you spendthrift.
6. The trap of Cash Withdrawal from Credit Cards
The cash limit is typically included in the credit limit available on a credit card. Most banks offer 20% – 40% of the total credit limit as a cash limit.
For example, if the total credit limit on a card is Rs. 2,50,000, you can withdraw up to Rs.50,000 to Rs.1,00,000 as cash using the card.
Though your credit card also has a cash credit, you should use it only in case of extreme urgency.
As much as possible, You should avoid Cash-Withdrawal from your Credit Card.
Why?
Because there won’t be any interest-free window of up to 45 days!! You will be charged with the interest from the moment you make a cash withdrawal from your credit card.
For example, let’s say if you withdraw ₹20,000 using your credit card, you will be paying the extra amount of at least ₹5000-7200 p.a. when you repay it.
For instance, if the ATM withdrawal fee is ₹600 and the applicable rate of interest is 3% per month, and you make one cash withdrawal of ₹20,000 using your credit card and repay the amount after a month, then you will have to pay ₹21,200 (plus taxes) to your bank, which will include the principal amount of ₹20,000, a fee of ₹600 and interest of ₹600 for a month. The interest amount will further increase in the upcoming years.
7. The trap of offers on credit cards
Are you a person who goes behind offers?
You might have seen Cash-Backs, Rewards and Offers. But all these are often a trap.
Have you noticed, all these come with terms and conditions applied?
For eg: You will have a cashback of Rs.200 if you paid Rs.2000.
Completing these offers within a stipulated time and also looking after your budget is difficult, sometimes not possible too. Spending Rs.2000 for a cashback of Rs.200 is meaningless. These rewards are only there to make you spend more than you should.
In a study conducted on the spending habits of the people, it was found that spending and debt increased by Rs.6000 and Rs.15000 respectively, a month, for a cashback reward of Rs.2000.
So beware, next time when you see any offers, don’t fall prey to them.
8. The trap of multiple fees
Other than the regular annual fees, some credit cards have additional fees. This fee varies depending on how you use the card. You will be charged additional fees if you
do not make the minimum payment, for exceeding the credit limit and for withdrawing cash. Hence make sure to understand your card’s fee structure.
9. The trap of sinking into a bad credit score
A bad credit score will harm your financial life. If you have not paid any of your previous loans on time or if you are into any of the above 8 Credit Card Trap listed above, you will automatically sink into the trap of a Bad Credit Score. And, a bad credit score will have the ill effects as mentioned below:
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1. Bank will not sanction your loans easily, they will complicate the loan processing. If your score becomes too low, the bank will outrightly reject the loan application.
2. A bad credit score will increase the chance of disapproval for any premium credit card, that you may want to apply for.
3. A bad credit score will affect your Credit Limit. Banks will hesitate to provide you a card with a higher credit limit.
So, never let your credit score go down. If only you can make use of your credit cards optimally, your Credit Score will continue to go up.
“Once you get into debt, it’s hell to get out. Don’t let credit card debt carry over. You can’t get ahead paying eighteen percent.” – Charlie Munger
Now that we have seen 9 credit card traps to avoid, let’s see what are the other possible ways to avoid this credit card debt trap.
5 Ways to Avoid the Credit Card Debt Trap
1. Make a budget to avoid the debt trap
If you make a budget you are less likely to fall into a debt trap. It is a plan on how you wish to spend your money every month. First, calculate your expenses and income for a month. Now deduct your expenses from your income.
To do this, here is a simple and easy to use Income and expenses tracker. Just enter all your incomes and expenses and you will automatically get your net income.
If you get a negative number, it means that you are spending more than your income. So you have to cut your credit card spending or you will have to earn more to make your cash flow positive.
2. Credit card balance transfer
If you are paying high interest and want to save money, you may transfer high-interest credit card debt onto a lower-interest credit card. It must also have a 0% balance transfer fee.
3. Try to avoid credit cards
If you are relying more on credit cards, then try spending in the form of cash or debit cards. You can also temporarily block your credit card, so you wouldn’t spend just like that. If you have your credit card number stored on any website, you can remove it as you may fall into the debt trap with a single click. Also, you will stop making impulsive purchases and only use the credit card in case of an emergency.
4. Find alternative loan options
Finding other ways to get money when you need it is a better choice. To get out of credit card debt traps, you may get a loan. The interest rates are comparatively lesser on loans. This can help you get out of the debt trap faster.
5. Create an emergency fund
It is good to have an emergency fund, so in case of any unforeseen circumstances, you would not use a credit card. Here is an easy to use emergency fund calculator.
This calculator will help you find how much you should be saving for an emergency.
Frequently Asked Questions (FAQs)
- 1.) Why is it not a good idea to withdraw cash from a credit card?Credit Cards doesn’t have any interest-free window of up to 45 days!! You will be charged with the interest from the moment you make a cash withdrawal from your credit card.
You must pay an ATM or bank fee, and the applicable rate of interest is typically 3% to 5% per month on the total amount of each cash advance you request.
As much as possible, You should avoid Cash-Withdrawal from your Credit Card.
2.) How many credit card one should have?It is advisable that you use only 2 credit cards at a time.
The more credit cards you have, the more will be the maintenance issues, their annual charges, and the more chance of you forgetting their bills and hence, getting deeper into debt.
3.) It is better to take loan or use credit card?
If you do not optimize your credit card you fall into debt trap resulting in bad credit score. Finding other ways to get money when you need it is a better choice. To get out of credit card debt traps, you may get a loan. The interest rates are comparatively lesser on loans. This can help you get out of the debt trap faster.
4.)How much interest will I pay on my credit card each month?
Credit card interest rates typically vary between 2.5% and 3.5% per month. This, however, may differ from one issuer to another, as well as from one card to another. It is usually preferable to use a credit card with a low interest rate.
Conclusion
Credit Cards can be beneficial if you use them optimally.
Otherwise, it will get you under any or all of the 9 traps listed in this article. The ill-effects of these traps will keep growing exponentially with each passing month and year if they are not taken care of; and ultimately you will get a bad credit score, as a result!
Therefore, use the credit card not to become spendthrift but to become financially smart.
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