Disadvantages of credit cards: a detailed analysis

‘What are the disadvantages of credit cards?’ is a common question put by the people who want to start their journey with this plastic card. In this lesson, we are going to discuss it.

You know that credit cards are different from debit cards. A debit card is linked to your savings account. So, your bank balance goes down with each swipe of the card.

However, this is not the case with a credit card. It is just like a loan account and not connected to your savings account.

Your credit card is essentially a debt instrument. It means you are borrowing money from the card issuer each time you make a transaction. So, transacting on your credit card enables you to spend money that you don’t possess. Hence, it can have both advantages as well as disadvantages. However, we are limiting our discussion to the disadvantages of credit cards in this lesson.

Disadvantages of credit cards

1. THEY COME WITH SOME HIDDEN CHARGES

It is a human tendency to grab everything that comes with a label ‘FREE.’ However, you should know that nothing in life comes free. You have to pay the price for everything. That is also true with credit cards. However, the credit card issuers try to convince you that they don’t have any hidden charges. But the truth is far beyond.

Credit card companies might charge you in the following ways:

  • Annual Maintenence charge
  • Late payment charge
  • Interest charge
  • Overdraft charge
  • ATM withdrawal charges
  • Goods and Services Tax

The list goes on. Generally, the credit card companies don’t reveal all these charges at the beginning. For instance, when a credit card company offers you a ‘free’ credit card, that entitles you a free ‘joining and annual maintenance fee’ for one year only. They continue to charge it from the next year. Therefore, it is your responsibility to check out if the offer is limited to one-time or it is life-time.

2. THEY CHARGE A HIGH-INTEREST RATE

Your monthly credit card bill has two crucial figures. One is the outstanding balance amount, and the other is the minimum due amount. However, in most cases, people prefer to pay the minimum due amount only as it is a small amount. Once, you pay only the minimum due amount. Then the outstanding balance amount will attract a high-interest rate daily. Yes, you heard it right. Thus, it becomes a little bit confusing to an average person.

Here is a list of credit card types and the interest rate associated with them for your reference.

Credit Card TypeInterest Rate per monthAnnual Percentage Rate (APR)
HDFC Bank Regalia Credit Card3.49%41.88%
American Express Membership Rewards Credit Card3.50%42.00%
SBI Card PRIME3.35%40.20%
ICICI Bank Platinum Chip Credit Card3.40%40.80%
American Express Platinum Reserve Credit Card3.50%42.00%
HDFC Regalia First Credit Card3.49%41.88%
SBI Card Elite3.35%40.20%
Citi PremierMiles® Credit Card3.40%40.80%
Standard Chartered Manhattan Platinum Credit Card3.49%41.88%
Sources: https://www.paisabazaar.com/credit-card/interest-rates/

As you can observe, the interest rates are incredibly high. However, there are two things to note here; one is that different card types come with varying charges, and the other is your CIBIL score does not play any role here. It means a good CIBIL score does not mean the rate of interest will be favorable to you. It is a flat rate. Thus, it can be a debt trap and one of the most significant disadvantages of credit cards.

NOTE: Rates of Interest on credit cards change from time to time.

3. CREDIT CARDS TEMPT YOU TO SPEND MORE

According to research conducted by Drazen Prelec and Dunken Simester of the Sloan School of Management at MIT, people using credit cards show a willingness to spend more than those using cash transactions.

In cash transactions, you look at your pockets and spend accordingly. However, it does not happen with a credit card because you are not paying your bills right now. Further, you can pay the minimum balance amount or repay it in installments also.

Above all, in cash transactions, you pay in cash, and that can be painful. You feel that you paid money in exchange for something. However, a credit card payment needs only a swipe. There was no touch, no feeling, no emotion with your money. Therefore, you try to justify your purchase, not the cost. It is a phenomenon called ‘coupling.’

A credit card makes you feel that you have more money to spend. You feel more luxurious than your current financial position. So, you spend more. That’s simple.

4. CREDIT REWARD POINTS ARE WORTHLESS

Reward points are nothing but points you get with each credit card transaction. Your credit card company encourages you to make more transactions to get more reward points. Once you reach specific reward points, you can redeem them in the form of vouchers, cash-back offers, etc. It encourages you to spend more than your budget permits.

It is like showing a carrot and sucking you. To give an example, Simply Save SBI card gives you one reward point per Rs 100 spent. It translates to only 1% of your spending. To get that 1% reward point, people like to purchase that they don’t need soon.

The redemption of those reward points tells you another story. They have catalogs that include the various categories of products like dining, footwear, clothing, movie tickets, etc. That means you will spend on things that you don’t need to get reward points, and then they have restrictions on where to use those reward points. That sounds non-sense.

However, a few credit card companies allow you to encash those reward points. But that is hardly 1-2% of your spending. On the other hand, you can get better deals at a local shopping center or a shop next door.

5. IT AFFECTS YOUR CIBIL SCORE

In our lessons on the CIBIL score, you see that it is an important parameter our lenders use to approve loans. It helps us to get faster loan approvals and negotiate interest rates.

Credit card companies take into account your CIBIL score to approve a credit card also. However, you cannot negotiate with your credit card issuer on the rate of interest they charge for your dues.

Most importantly, your CIBIL score gets negatively impacted once you pay dealy your credit card dues.

You must understand that a credit card is nothing a loan on a plastic card. You make big purchases to get reward points and another unnecessary purchase to redeem it and get into the debt trap unknowingly. Meanwhile, you forget to pay on time. That is what your credit card company wants to make money in the form of interest. Consequently, your CIBIL score goes down.

A few months later, you approach a bank to take a personal loan, auto-loan, home-loan, etc. then they charge you a higher rate of interest as your CIBIL score is compromised. That’s a trap.

6. WE GENERALLY BUY LIABILITIES USING OUR CREDIT CARD

I hope you understand what an asset and a liability are. An asset is something that appreciates over time and makes you profitable. On the other hand, a liability depreciates over time and drains out your money.

Are you buying assets using a credit card? I am sure your answer is ‘NO.’ However, you may argue that liabilities are a part of our life. I also agree with you. However, it should take a small space in your life. But the problem is that for most of us, it plays a dominant role.

You prefer to fly as you have air miles. You replace your shoes only to redeem your reward points. Further, you watch a movie only because it is free. For me, it is the sheer wastage of your productive time and your valuable money.

You know that buying assets and using your productive time efficiently can add more value to your life. Further, it can take you to the next level.

7. THEY COME WITH SOME VAGUE TERMS AND CONDITIONS

You have to sign a few papers at the time of your credit card issuance. Do you have gone through all those terms and conditions? I am sure you have not. The reason for this is simple. It is written in small letters that you feel difficult to read or don’t think it is essential.

However, it is a common mistake most of us do regularly. For example, you take a health insurance plan but did not care to read its terms and conditions. Finally, something unpleasant happens to you, and you realize your mistake. On the other hand, you cannot drag the concerned company to court as you have already accepted the terms and conditions and signed on the paper.

The same thing happens with the terms and conditions of the credit card. It gives you detailed information on the rate of interest that they will charge you for your dues. It also notes the hidden charges that they generally don’t disclose with you.

Remember, it’s you who is responsible, not the credit card issuer, for not knowing the terms and conditions. I suggest you ask for a copy of the same from your issuer or download it online and read it seriously before something wrong happens. It is just good practice, nothing more.

8. SOME OTHER DISADVANTAGES OF CREDIT CARDS

You know that credit card fraud cases have increased over a short time. Therefore, making transactions using your credit card may be riskier than cash transactions. For example, in just three months of October-December 2019, Rs 129 Crores has been lost due to various types of online frauds, including credit card transaction frauds.

Further, if you use the credit card to withdraw cash from your bank’s ATM, then it attracts an interest that is called ‘credit card-cash advance fee.’ It is around 2-3% of the transaction amount or a minimum amount ranging from Rs 300 to 500.

A credit card surcharge is another disadvantage of credit cards. For example, if you buy petrol using your credit card, you may have to pay a surcharge fee of a flat rate or around 2.5% of your transacted amount. However, a few credit card issuers waive that fee for a particular price band i.e., Rs 500 to Rs 2500, etc. Therefore, it is always good to check out the terms and conditions of your credit card to avoid these types of fees and surcharges.

These are some of the disadvantages of credit cards.

A closing thought on the disadvantages of credit cards

Credit card companies are here to make a profit. They are doing their businesses. There is nothing wrong with their business model. Further, you can have a look at the profit and loss statement of SBI cards and payments services Ltd. It is a subsidiary company of State bank of India.

Particulars31-Mar-1931-Mar-1831-Mar-17
Total Revenue 72,868.3553,701.9234,710.38
Profit After Tax8,627.226,011.423,728.61
[Figures are in millions]

It is growing at a rate of more than 50% CAGR (Compound Annual Growth Rate). It’s a fantastic growth rate. But, you should remember that the cardholders are not making money. It is the company that makes money.

It is also true with other NBFCs that provide you credit. Further, some of them have proved themselves as multi-baggers. Therefore, it’s you who have to decide to invest in these companies to take the opportunity or become a victim of it.

Further, a card cannot have any advantages or disadvantages. It is always the people who use it. Therefore, if you think you can use it properly and have the right mindset, you are most welcome unless you stay away from it.

We are going to discuss the advantages of a credit card in our next lesson. Stay tuned.

I hope you enjoyed the post. You can share it with loved ones with a single click. Further, I need your comments, suggestions, and opinions to create more value for you.

Thanks and regards,

finguru@finlessons.com

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