Don’t shy away from credit cards – just know better about it

“Live within your means.” How often have we heard this from our elders? I still remember how freaked out my mother was when I received my first credit card. My family considered owning credit cards taboo. She immediately reported the incident to my dad.

He gave one of the most rousing speech I have heard to this day. I was always a rebellious know-it-all (not proud btw) and beyond a point, he grew tired and just gave up. Of course, as with any reckless kid, I learnt my due lesson. Hold on, I am jumping gun a bit here. Let me start again.

One of the most popular (and one of the few) financial lessons taught to us is “Never spend the money you don’t have” It absolutely makes sense. I know tones of my people who consciously shy away from credit cards. And its not even a sporadic event. I did some digging about. We, Indians are super reluctant to use debts and credits. 

Debt Averse Indians

Let’s take household debt to GDP ratio for example. It is nothing but sum of all debts (loans) accrued by a common household. Common debts usually include home mortgages, home equity loans, vehicle loans, educational loans and credit cards. So compared with the overall GDP, one can get a fair idea on how credit oriented people are in a country.

For India, this figures stands at a meagre 12.2% as on December 2019. To put things in perspective, the corresponding figure in US is 75.40%; China is at 55.2%; Germany stands at 54.40%. Forget developed countries (and China, duh), we Indians are so credit averse that even less developed countries like Malaysia, Thailand and Brazil out borrow us.

Household debt to GDP ratio for India compared against global peers
Household debt to GDP ratio for India is one of the lowest among global peers meaning we are just not into get debts

Don’t expect “We want to offer a lifetime free credit card exclusively for you” or “We saw your credit score and are eligible for instant personal loan of ₹XYZ” calls go away any time soon. For all big companies, India is still a grossly underpenetrated market with one of the youngest population eager to indulge.

A lower debt/GDP means that the country is producing enough to pay off their debts. Of course, there is nothing wrong in us being a debt averse nation. However, when we go one-level deeper to understand what comprises of debt, things get interesting.

Analyzing what comprises household debt of India, credit cards contribute just 4%. over past 5 years
Credit card debts in India is still very much at sub 5% levels

Of a whopping ₹ 25.55-lakh crore household debt book, we had last financial year, credit cards contributed to just 1.08 lakh crores or roughly 4%. Moreover, this is the norm and has been more or less same for the past 5 years, even though the credit card debt has grown at a CAGR of 23.5% in the same time.

All this points to an obvious conclusion that we, Indians, just aren’t into credit cards. Herein comes the unpopular opinion, are we being too risk averse? Are we holding on to the outdated advice and missing something? I certainly have few reasons to believe so.

Credit cards do have their benefits

Owing credit card offer three significant benefits and no, I am not talking about instant availability of money you don’t actually own.

Establish your credit score

For some of you who don’t know what credit score, it is basically the ‘probability of default’. Before you can apply for any loan be it housing, education, personal or vehicle, banks first check what your score is. Higher the score, lower is your probability of default and more likely loan is granted. Scores calculation depends on your history of paying back on time.

Herein comes the caveat, first time buyers (read home, education and vehicle) will not have a credit score. Well, they’ve simply not borrowed before. Why will a bank entrust a huge amount of money on people whose repayment trend is unknown. Therefore, either they reject the loan request or levy a premium on interest rate.

To overcome this and create a trail of repayment history, credit is the best way. Your credit card expenses comes under “credit”. The best part is all other credit mediums levy a fixed interest charge but with credit cards, you will have to pay nothing as long as you pay your full balance of credit on time. You will not only be obtaining loans quickly but also at best possible rates.

Grace Period:

You get things now but actually pay only after a month (or 45 days for select few cards). In essence, you are postponing the cash out by a month and are maintaining your free cash flow.  Hanging on to your funds for this extra time can be helpful. Your cash will spend more time in your bank account, and if it’s an interest-bearing account, then you earn on your money during the grace period. The extra will eventually add up to a meaningful amount as against paying with a debit card, cash or check.

Rewards and cashbacks

Almost all credit cards offer hefty rewards. With extensive partnership chains all over the globe, the purchasing power these reward points are good. Roughly, you can hope for a 1-2% worth discounts in the form of reward points and frequent flyer miles. If you get into premium programs, you will also end up having concierge services, complementary events and so on. For family people who simply don’t bother about all these, you can opt for “cashback” cards which will reimburse a percentage (1-2%) of overall expense as cash in your account.

Emergency Fund:

We spoke about importance of emergency fund. On the chance you failed to heed to our advice, credit cards offer you a shortcut. For all your unanticipated expenses like sudden breakdown of your vehicle, unexpected leakage in your house or an impromptu big family dinner during month end.

Mistakes bleed you dry

Now, going back to the beginning of the article, these were all the reasons why I bought myself a credit card. And as with any stubborn, Know-it-all (again I can’t emphasize it enough I really am not proud of it) brats, I learnt my lesson the hard way.

I was very disciplined in maintaining my credit health. Initial few years, I was always on time in making full on time payments. I had a very healthy credit score and life was good. Then came the proverbial hammer. Once, I let my impulse take control of me. I swiped an amount too big for paying it back on time. For academic purposes let us assume it to be ₹500,000 I consoled myself saying I will pay it back over next couple of weeks.

However, since the amount was now billed, I was a bit relaxed and carried away knowing I will pay it off. New month new expense, newer thing to buy. Couple of weeks became a month, and then a month became couple of months. I knew I owed them, but it just wasn’t so much of a pressure. I took my own sweet time and finally, I closed the credit 8 months from the date of my purchase.

When I summarized, I had paid ₹590,000 for my initial loan. That was an annualized return of whopping 27%. My credit card company made profit off me by doing nothing but waiting for my first mistake. Luckily, I recovered from it, but this common mistake leads many investors on a trap, spending precious time of their youth stuck with debts instead of investing.

Credit is like red wine. One glass a night is certainly healthy. A bottle every night, you become an alcoholic. Credit used wisely and in moderation can actually save you from lot of trouble, no matter the economic conditions are. Use it haphazardly; however, you will wake up in the middle of the road without an iota of clue as to how you even ended up there. I would like to sign off with a story.

Even the mighty are wary of credit cards

The stage set was Berkshire Hathaway’s AGM 2020. For some who might not know the owner of it, he used to be the richest man in the world and considered a modern legend of wealth accumulation. He goes by the name Warren Buffet, the multi billionaire.

In the first-ever virtual AGM of Berkshire Hathaway, Mr. Buffet recounts a story of when his friend sought his advice on what do with the money she recently came into. His first question to her was whether she had credit card debt. She did at 18% p.a interest. Then Mr. Buffet goes on to quote:

“If I owed any money at 18%, the first thing I’d do with any money I had would be to pay it off. It’s going to be way better than any investment idea I’ve got. I don’t know how to make 18%,”

Warren Buffet (in his first ever virtual AGM held this year)

Here is one of the most powerful businessperson the world has ever seen; he has businesses in every corner of the globe; he has so much earning power that he once made $3.5 million just to have dinner with someone. Yet, he says he can’t give a better return that the interest credit cards levy. He doesn’t stop there however, he goes on to add

“You can’t go through life borrowing money at those rates and be better off”

This, mind you, from the largest stakeholder of American Express, one of the most premium credit card brands across the globe. Even the single biggest benefactor from erratic spending is giving a fair warning that you simply shouldn’t let your credit card debts carry on.

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