Just like my article on unit trust, I have refrained from credit cards over the past 4 years of my working career not because they are bad but because I never understood how they work. The word “credit” somehow manage to keep away as it sounded like debt to me. Last month, I picked up “Money user’s guide” by Laura Whatley which had a topic on credit cards. This was an eye opener and I am here to share what I have learnt so far.
So what is the main difference between a credit card and a debit card?
In principle they are all the same. They allow you to purchase items and pay for bills but the only difference is where the money is drawn from when a customer make a purchase. For a debit card, when you buy something, your available bank balance goes down by the amount you swiped and this amount is added to your blocked funds so that you cannot spend it twice. On the other hand, for credit card , when you swipe, that amount is added to how much you owe the bank and your liabilities increases. With each purchase that you make , you owe the bank more money where as with a debit card, with each purchase that you make, you have less money for future spending.
Here is how credit cards work: You get a credit card with an allocated credit limit. The limit is how much you are allowed to spend, which ultimately is equivalent to how much the bank has loaned you. It’s similar to getting a loan but instead of getting in cash, you get the buying power worth that much. You then have an various option on how you can repay the money back and to incentives you to use it, there is often an interest free period. This is the period that you have where you do not pay any interest on the money you owe. If you can settle the balance in full during that period, then its similar to actually spending your own money.
The main issue with credit card is self discipline. The limit you are allocated depends on your income level and the higher your income, there more money you are likely to have at your disposal. The issue is, often people spend the maximum allowed within a month but are unable to repay back the money within the interest free period. Any payment beyond that, will attract interest and short term interest rates are likely to be higher.
There are other various benefits such as earning cash back and points when you buy using your credit card which can come in handy if you travel a lot. However, if you are spending too much just to earn points, your points that you will earn will be useless if the interest charged on the account exceed the benefits that you are getting from the points.
The key is when taking out a credit card is to consider the followings
- What are the key features of my credit card? My monthly limit, the interest free period as well as what I am allowed to do and not allowed to do? These are some of the questions you can ask your banker when you are signing up for a credit card.
- If you can, your priority should be to use your debit card first as that is the money you have and only when its necessary, use the credit card if there is an advantage such as swiping and getting points.
- Consider what your fees are on your account? There is an initial set up fee and a monthly management fees. I did a brief google search and an FNB Premier Credit card has an initiation fee of N$175 and a monthly fees of N$87. Add this to what your normal monthly management fee is on your checking account. Do the math you could be spending over N$500 on fees alone for the month if you have too many cards.
- Be discipline and spend responsibly. The ideal situation is to take advantage of the interest free period. This is not that long so you need to see if you borrow something, you will be able to pay it back. Again with FNB, the longest period of interest free is 55 days. That is less than 2 months. Will you be able to settle your balance in full?
I hope that helps in evaluating whether or not you should take out a credit card. Give it some thought, but credit cards are just loans with a few benefits.
Do you have a credit card? How much is it costing you?