Dubai: Credit cards are a great way to build credit and pay for expenses, but when misused they can damage your credit score and cost lots of extra money.
Carry a balance and pay high interest rate charges. Miss a payment and incur a late fee. Close a credit card and ding your credit score. The costs add up quickly.
1. Do you pay only interest fees or minimum payments when you send in your credit card payment?
2. Have you ever paid your credit card late because you didn’t have the money for the payment?
3. Do you use your credit card when you don’t have enough cash?
4. When your issuer raises your credit limit, do you spend more because you can?
Here are some common credit card mistakes you might be making and how you can avoid making these mishaps. The users of credit cards should be careful of the following seven credit card habits:
1. Using credit cards only for rewards
The issuing authorities of credit cards try to entice customers with various reward schemes to maximise the use of credit cards.
However, cardholders should remain cautious and use the card only if they need particular products or services. Let’s say you purchase unnecessary things to get earn more and more reward points.
You would then end up purchasing even more unnecessary things just to use the reward points before they get lapsed when you find that there is no useful things in the reward catalogue to buy.
As said by business magnet and investor Warren Buffet, “If you buy things you do not need, soon you will have to sell things you need.”
2. Carrying a balance month-to-month
One of the biggest credit score myths is that carrying a balance on your credit card improves your credit.
In fact, a global survey indicated that 22 per cent of people carried a balance thinking it would increase their credit score. In reality, carrying a balance month-to-month hurts your credit score and costs you.
If you carry a balance, you’ll have a higher credit utilisation rate, which is the amount of debt you have compared to your available credit.
Experts agree that the lower your utilisation rate, the better. A study found ‘high achievers’ — consumers with an average 800 credit score — on average use a mere 7 per cent of their credit limit.
Carrying a balance can also get expensive thanks to interest charges. While a cash-back card can help you save money on your everyday spending, all that savings is for nothing if you’re paying interest.
3. Overspending on indulgences
Credit cards make purchases easy, as cardholders needn’t bear the pain to visit a bank or an automated teller machine (ATM) to withdraw and spend money.
Moreover, the card may be used to purchase a thing for which you don’t have enough money in hands and rely on future earnings to pay the bill. You should then go for the purchase only if it is necessary.
Overspending on indulgences is a bad habit, which may force you to postpone credit card payments and, if not checked, it may not only hurt your credit score, but may ultimately make you bankrupt.
So, always remember that credit cards should only be used during times of emergencies and not for luxury purchases.
4. Rolling over card payments
While you should always make at least the minimum payments, it’s not advised to only pay the minimum due.
Banks give options to make minimum partial payments that often misled cardholders into thinking that it’s fine not to pay the bill amount in full.
But remember that credit cards have ceiling interest rates. A partial payment may save you from late payment penalties, but it will still incur interest rates until you settle your balance.
Only paying the minimum can add months — even years — to the time it takes you to pay off debt. So, spend only that much through your card, which you can pay on or before the due date of bill payment.
Have a payment plan in place before you take on bigger expenses, and always make consistent, on-time payments toward your balance.
5. Missing a payment
Late or missed payments can seriously hurt your credit score if you’re more than 30 days past due.
You can expect a drop of 17 to 83 points for a 30-day missed payment and a 27 to 133 decrease for a 90-day missed payment, according to a compilation of data from credit bureaus worldwide.
However, if your payment is less than 30 days late, you won’t see a drop in your credit score since a payment has to be a full 30 days past due before it’s reported to the credit bureaus.
But you may incur a late fee or penalty interest rate — which raises your card's annual percentage rate or APR (the credit card's interest rate, which is the price you pay for borrowing money).
Set up auto-pay to ensure payments are always made on time. And if auto-pay isn’t for you, set reminders and email notifications.
6. Using EMI options for credit card dues
EMI schemes appear very attractive and easy for making high-value purchases.
However, remember that ‘what’s often free comes at a cost’. So, you need to figure out whether it’s really a good idea to convert your credit card balance into EMIs.
In case you are in a tight financial position and about to default on paying credit card bills, it will be good to use the option as it is better than defaulting on your payments, which will hurt your credit score.
So, unless very necessary, one should avoid EMI option, as it not only inflates the cost of the product, but also attracts additional fees and creates long-term debt.
So, using the EMI option to buy a house may be justified – where cost is too high to pay out of pocket. But not for that expensive high-end mobile handset, whose 70 per cent features you may not use.
7. Ignoring credit score
Credit score is a number based on credit reports, which is a summary of past and current borrowings and repayment history.
Your credit score gets hurt when you have more credit balance in relation to your credit limit, making it difficult for you to get a new credit card or apply for a loan.
The average length of time you’ve had credit is one factor making up your credit score. When you close a credit card, the average length of your credit history is affected.
For example, if you have a card that’s 5 years old and a card that’s 2 years old, you’ve had credit an average of 3.5 years. If you close the 5-year-old card, your age of credit decreases to 2 years.
It’s not advised to close a credit card, especially your oldest card. But at times it can make sense to close a credit card, such as when you’re charged an annual fee that isn’t outweighed by its benefits.
But the bottom line is, to remain creditworthy, you should keep an eye on the credit score and use your card wisely by avoiding these bad financial habits.
4 lessons to learn in order to take control of these credit card habits
Lesson #1: Using credit card rewards and points to your advantage
If you have a rewards credit card, you can use it to your advantage. If you have a pure cash back credit card, use any cash rewards you receive to put toward your account balance or directly deposit it into your savings account.
Alternatively, if you have a rewards points credit card, you can use your rewards to buy discounted gift cards to the stores you know, which will help save on future purchases without having to use your credit card.
If not, you could always redeem your reward points for cash redemption to put into savings or towards your account. However, ensure you know when your rewards expire to get the most out of them financially.
Lesson #2: Pay your credit card in full each month
The best way to keep your credit utilisation ratio low and avoid costly interest charges is to pay your credit card balance in full each month – which also means you also don’t incur any large due.
It’s effective to control spending by not spending more than you can comfortably pay down each month, as this helps you reduce the likelihood of developing long-running credit card debt.
If you want to take in one step further, setting a monthly spending limit that's well within your budget increases the chances that you'll actually be able to zero out your monthly balance and avoid interest charges.
Lesson #3: Keep your credit utilisation ratio low
What it means by ‘credit utilisation ratio’ is essentially the link between your credit card balances and your aggregate spending limit. For example, a Dh2,000 balance on a credit card with a Dh5,000 credit limit equates to a 40 per cent credit utilisation ratio.
As a rule of thumb, your credit utilisation ratio shouldn't exceed 40 per cent, and keep in mind that high ratios may adversely impact your credit score.
Financial advisors recommend aiming for a 30 per cent credit utilisation ratio, as that gives you some leeway to cover urgent one-off expenses, which can come unexpectedly as a result of maybe losing your job during the ongoing pandemic.
Lesson #4: Setting up customised spending alerts
If controlling your credit card spending is burdening you, it has been widely advised to set up customised spending alerts.
This will let you know when you've made an abnormally large payment or exceed a certain balance threshold and you also can pair these data alerts with security alerts to help flag any sham spending patterns.