Credit Cards – A ‘Debt’ Sentence?

Rishi Khanna, 26, is a resident of Gurgaon. He holds 2 credit cards – each with a limit of Rs. 50,000 per month. However, he religiously pays off his outstanding amount on both cards each month. In addition, he checks his card statements every Sunday, in a disciplined manner, and maintains a steady awareness of his total outstanding amount across his two cards at all points of time.

The case is different for Shombhit Sen, 28, a newly married resident of South Delhi. He has at least five credit cards stashed away in his wallet – each with a limit of Rs. 75,000 per month. “They keep offering them for free”, he says. “Why shouldn’t I oblige?”

Shombhit is self-admittedly reckless when it comes to his card usage. Unable to resist the lure of easy loans and “quick EMI’s”, he’s racked up quite an outstanding amount on all his cards, combined. When asked about the total outstanding amount on his cards altogether, he says that he avoids opening his statements in order to “spare himself the horror”. He pays off the minimum due each month, but his ability to even pay off those amounts is waning with each passing month.

According to data published by Worldline E-payment Services, the total number of credit cards in India has stands at approximately 21 million as on date. The question is; how many of these 21 million users are using their cards responsibly, and how many are slowly but steadily sinking into financial quicksand?

“Credit cards, on one hand, are very convenient and beneficial payment & short term credit instruments but on the other hand, it is very easy to slip into ‘revolving behavior’ and end up paying interest charges as well as hurting your credit score”, warns Naveen Kukreja, CEO& Co-founder, Paisabazaar.com.

The psychological aspect
Spending cash pinches, right? The process of pulling out the bank notes from your wallet and making a payment makes you actually feel like you’re physically ‘parting’ with something. A card-swipe provides a quick and seemingly painless solution to the pain of watching your hard earned cash float away!

Other related research into human psychology has shown that the very act of making a payment is what actually causes grief – the actual amount being paid wasn’t exactly correlated with the degree of grief being experienced. In other words, making one payment into a credit card account at the end of the month is less pain inducing than making fifty separate cash payments throughout the month - or for that matter, fifty payments from your debit card, which are really tantamount to spending cash.

A third psychological aspect needs to be considered – that of ‘hyperbolic discounting’. This is essentially a mental phenomenon which forces you to attach undue significant to immediate pleasures, leading to impulse spending and the inability to delay gratification.
These three aspects collude to form a heady cocktail, inducing many into a revolving cycle of debt that can hurt their finances in innumerable ways in the long run.

What is a credit card really for?
Credit cards have interest free periods which range from 20 to 50 days. Sounds great, right? Wrong, because there are no free lunches in this world. By extending an unsecured loan to you for a period of 20-50 days, the card issuer is taking on a significant risk. In order to compensate themselves for this risk, they need to charge a commensurate interest rate and late payment fee. This interest rate is usually 2.5-3 per cent per month, which works out a 30-36 per cent per annum. To top it off, you could be charged a late fee ranging from Rs. 500 to Rs. 1000. Could it get any worse?

A credit card really needs to be viewed as a convenience tool, more than anything else. Remember, when you’re spending on a card, you really are spending your future cash flows. You really should be saving your future cash flows for your financial goals instead.

Traps to avoid
There are a few simple traps to be avoided when it comes to your credit card usage. First, don’t hold too many; one VISA and one Mastercard will work just fine. You’ll be doing yourself a big favor by cutting up the rest. Second, resist the temptation to increase your spend limits, even if you’re being goaded by the bank to do so. Third, track your total outstanding weekly – your balances can build up deceptively fast. Fourth, always pay off the full outstanding amount before the due date, even if you need to draw upon your investments or borrow from friends and family to do so. Fifth, avoid taking loans on your card – save up cash and delay your purchases instead.

How to get unstuck
If you’re stuck in a vicious cycle of revolving credit, you need to get unstuck right away. As with any positive change, the process must begin with a deep and sincere commitment to the cause coupled with and a positive mindset. Getting unstuck from a credit card debt sentence is no easy task, but one that your future self will thank you for.

Begin by taking stock of the total outstanding amounts on all your cards and detailing them clearly in an excel sheet. If you have enough assets or can reach out to well-meaning family members or friends for support, mobilize this amount and pay off the total debt right away.

If you do not have any such source of funds, you may need to undergo a significant degree of ‘fiscal consolidation’ by cutting down current spends and getting rid of so called luxury items which might be costing you an arm and a leg in terms of an EMI or recurring maintenance. This isn’t going to be easy on the ego, but nevertheless is something that needs to be done. Free up enough from your monthly P&L to prioritize paying off your card outstanding within 12-15 months, and then pick up the pieces and begin again.

Kukreja of Paisabazaar.com offers some wise words of advice to those looking to get off the revolving credit trap. “Firstly, stop using that card till you clear off full outstanding as the interest would get charged even on the new purchases. Secondly, try to clear off the full payment immediately through your own means, borrowing from friends or family, converting the full outstanding into easy EMI’s from your card company or taking a personal loan form a bank (interest rates ranging from 12  per cent to 20 per cent) in that order of preference”, he advises.

Final words of advice in parting – if you tend to spend indiscriminately, inculcate the habit of using your debit card instead. This simple act will go a long way in keeping you out of trouble in the long run. It seems tough to do at first, but as you get used to it, you’ll actually start enjoying the freedom and peace of mind associated with knowing that you’re spending what you actually have!

Having said that, if you can control your spends, use your credit card responsibly, and make your payments well in time - there’s always the associated long term benefit of helping build out your credit score. “If you use the credit card well and responsibly, it can also help build your credit history and improve your credit score over time – extremely useful when you take bigger loan products such as a Home Loan or a Car Loan”, says Kukreja of Paisabazaar.com in conclusion.