Imagine this scenario: Your brand new and the first credit card has arrived by courier.
Indeed, it is an ecstatic moment when you open this envelop and view the shiny, new card with your name. An enclosed letter informs about the credit limit you can enjoy. A brochure carries terms, conditions and other important information about this credit card.
Getting carried away is most often the first reaction whenever we receive our first credit card. It opens doors to stores and entertainment, travel and fine dining, even when cash in hand is low. We conjure visions of buying that expensive smartphone or getting the latest TV set, buying gifts for family and lots of other things that could not be bought with our income.
How Disadvantages of Credit Card Begin
Usually, we fail to read the brochure with terms and conditions or simply go through it without comprehending what it says or warns. Here is where the trouble usually begins. Undoubtedly, credit cards come with a wide array of advantages. But using them wrongly can land you in serious financial doldrums, adversely impact your credit score. Worse, you might end up with legal problems.
Therefore, here I will highlight the top 10 disadvantages of the credit card.
Top 10 Disadvantages of Credit Card
Hopefully, knowing these disadvantages of credit card might save a lot of money and other problems. Remember, prudent and cautious use of credit card is the best way to avoid these disadvantages.
1. Annual Percentage Rate
Whatever your credit limit, the bank or issuer will provide a facility to pay only between five and 20 percent of the outstanding amount. The minimum amount payable is decided by the issuer, usually your bank. Undoubtedly, this sounds a pretty attractive proposition while buying something very expensive. You need not worry about paying the entire amount in one go. Instead, you can settle the bill in easy instalments.
This is the single largest disadvantages of the credit card. When you pay only the minimum instalment, the issuer carries forward your outstanding. Rather, they do so willingly. Why? Because your unpaid amount attracts a form of interest, cleverly called Annual Percentage Rate (APR). This means the issuer will charge you during every billing cycle for any amount you have not paid.
This APR accumulates and reduces your credit limit. Worse, the outstanding amount with APR attracts more interest. This means, you are not only paying for your purchases, but the issuer is also charging you interest on the APR. In India, this APR can work as high as 43 percent per annum. Interestingly, a credit card issuer will never disclose this figure. Instead, they will claim to charge only between two and three percent APR on your outstanding amount. Often, this APR can land you in endless debt.
Overspending ranks as another top disadvantage of the credit card. This occurs because credit cards instantly increase your buying power. The credit limit and flexibility to pay in easy instalments tempt us to overspend. Consequently, we end up buying things we do not require, shop for expensive stuff or splurge money on holidays, gifts and festivals.
Understandably, overspending during a medical or other emergency is justifiable. But what about those shopping binges where you end up buying the stuff you would seldom use? Or what about that expensive gadget you would never have bought should you have to pay cold cash? Think of all the ‘special offers’ you bought on credit card despite having little cash on hand.
Credit cards are plastic money. Subconsciously, the pain of paying cash is conspicuously absent when using a credit card. Invariably, reckless spending leads to stockpiling of useless stuff at our homes. And it definitely lands you in financial doldrums due to high APR that comes into play when you opt paying in instalments.
3. Inability to Get Loans
High APR and overspending lead to third major disadvantages of credit card: your credit score takes a heavy beating. Nowadays, all banks and lenders look at your credit score while applying for vehicle finance, housing loan or personal loan among others. A poor credit score can automatically cause rejection of your loan application.
You might desperately require a vehicle for your work or buy a home for the family. Unfortunately, poor credit score due to the credit card will deprive you of loans needed to buy these important things and assets. You may have an impeccable spending and repayment record. Yet, having a credit card itself is usually taken as a liability by credit rating agencies.
4. Credit Limit Upgrades
Credit limit upgrades or credit limit enhancements are usually given by all issuers. This means you can apply for more credit limit on your card. Some issuers and banks will upgrade your spending limit automatically if you have shown proper spending and repayment pattern. Such credit limit enhancements lead to the disadvantage of the credit card.
Obviously, you do not require a credit limit enhancement if the due amount is settled fully on time, during each billing cycle. This means the bank does not get much APR. But increase the credit limit and spend more. Your credit card dues can assume monstrous proportions. Add to this the APR. A credit enhancement works only for those who are able to pay the full amount of money on time. If you are availing revolving credit, it is imminent you end up paying colossal APR.
5. Stiff Penalties for Late Payment
A credit card issuer has no problems as long as you pay the minimum outstanding amount before or on the due date of a billing cycle. But try missing out on such payment for any reason. An excellent repayment history cannot come to your rescue. The issuing bank or financial company will charge stiff penalties while enforcing other restrictions almost instantly.
While you will pay a late payment charge, other penalties can make holding a credit card a real disadvantage. This can be a very severe disadvantage if you travelling or do not have immediate funds to repay at least the minimum due amount. You might find the credit card frozen while in a foreign country or far away from home. Though net banking facilities are available, paying on time can become a problem if your area does not have proper Internet facilities to access the system on mobile or computer.
6. Cash Advance Facility
Every credit card comes with a cash advance facility. This means you can withdraw cash up to a certain amount of your credit limit from any ATM. Cash advance facility is available domestically and in foreign countries on your credit card, depending upon its type and issuer. Indubitably, this is an excellent facility. You can get cash in emergencies, especially when credit cards, debit cards or other forms of electronic payments are not acceptable.
However, this wonderful sounding facility comes at a not so attractive price tag. The credit card issuer charges around Rs.250 and upwards merely as cash withdrawal fees. Further, you are also liable to pay hefty interest on this cash advance and other service fees. Additionally, your credit limit gets depleted. Further cash advances will most likely be unavailable till you pay the full outstanding amount of the credit card.
7. Credit Card Frauds
Credit card frauds are nothing new to India. However, this sudden push towards a cashless economy and easy availability of credit cards has led to a spurt in frauds. E-commerce or buying stuff online- which is very popular in India now- also leaves enough scope for credit card frauds. These usually occur when credit card holders are unaware of how to use them safely to prevent frauds.
There are eight different types of credit card frauds worldwide. The story in India is no different. Often, credit card frauds occur because the holder is careless. Of course, there are criminals- both individuals and organized gangs that perpetrate credit card frauds. Yet, they too occur since the credit card user is not vigilant.
It can take months before finding out your credit card is being fraudulently used, if you do not check statements sent by the bank or issuer immediately. If the fraud is not reported to the police and the issuer immediately, you stand liable for repaying every penny spent by criminals. Till the issue is resolved, your credit ratings take a severe beating and your credit card itself may get suspended or cancelled.
8. Limited Acceptance in Rural Areas
Using a credit card in rural India continues to be a major hassle, despite the country’s relentless push towards a cashless economy. In most parts of rural India, debit cards and other forms of electronic payments are also not available due to the poor Internet and mobile connectivity.
Though the penetration of Point of Sale (POS) terminals across India is witnessing a rise, with over 341 million reported by March 31, 2018, the number of transactions remains lower. Other reasons for lower acceptance of credit cards in rural India also include the levy of fees by banks on merchants. Generally, banks charge the seller a small fee for every transaction. Rural merchants find this fee unreasonable since it eats into their small margins.
9. Insecure Systems in India
India lags in online security. This was amply proven in 2018 when hackers breached the database of Unique Identity Development Authority of India (UIDAI) and gained access to Aadhar data of citizens. Similarly, there are reports of bank databases being hacked and information about thousands of debit and credit cards being leaked. While some major cases are reported and criminals brought to justice, others continue to enjoy impunity.
Insecure cybersecurity systems deployed by some banks, financial institutions and government organizations is one of the main disadvantages of having a credit card. Unless your credit card issuer has foolproof systems, there can be no guarantees it is safe.
10. Credit Card Addiction
Credit card addiction? Sounds ridiculous and also impossible. Yet, this is one of the biggest disadvantages of credit cards. Indeed, credit card addiction is threatening thousands of Indians. In fact, banks and credit card issuers are taking serious note of this addiction that did not exist in India a couple of decades ago. However, with banks willing to issue credit cards to almost any eligible client, people with limited resources find themselves falling prey to such addiction.
There are several signs of credit card addiction. Thankfully, there are ways to get out of it too. Credit card addiction is closely linked to shopping addiction. People become compulsive buyers. And when they have no cash or credit, they apply for more credit cards to fulfil this unhealthy urge. They usually end up buying useless stuff. In worse scenarios, a credit card addict may need psychiatric help.
As we highlight, consumers put themselves at a disadvantage with credit cards in some instances.
Overall, I rate credit cards as an excellent resource to have. It provides instant access to money when we need it the most. Generally, those who use credit cards prudently and settle bills on time will not face much disadvantages.
But if you view credit cards are your gateway to shopping for unaffordable stuff, it will definitely land you in trouble. Understandably, banks do charge high interest or APR on your outstanding payment. Here too, the consumer is at fault: a bank cannot charge APR if you settle dues on time.
Everything in the world has two sides. The same axiom holds true for credit cards. While they offer immense benefits, using them wrongly holds severe disadvantages.