There is a general misconception that credit cards are intended to make you slave for the bank, due to the fees and interest rates associated with their use. However, like any other form of debt, it is the way you manage and service the debt that makes the difference. If you managed it properly, then a credit card can be a very powerful financial tool.
The use of credit cards in Kenya has increased substantially over the last 5 years, as more people make the shift from cash to card-based payments. However, as promising as this trend is, Kenyans are still wary of embracing credit cards as they are perceived to be too risky. A survey back in 2014 revealed a slow uptake of credit cards compared to debit and prepaid cards.
Credit cards are primarily used to make large purchases when you do not have enough money to meet the purchase cost. If used correctly they are valuable financing tools which can benefit consumers greatly. However, if they are not used in the right way they can end up costing more than what you originally budgeted for.
Let us examine some common credit card mistakes you can avoid:
- Spending beyond what you can afford: Spending more than you can afford, without a doubt, is the biggest mistake you can make when using credit cards. This usually happens when you use your credit card to buy consumer goods or to finance your leisure activities. Remember, credit cards are there to enable you to make purchases for which you do not have money for at the moment, but you shall get the money in the near future. Before you swipe your card ensure the purchase is something you really need and not an impulse buy.
- Missing or making late payments: Another serious blunder is to miss your monthly payments or pay the debt late. Late credit card payments erode the goodwill and trust you have built with your lender. In addition, you will be charged a late payment fee and a higher interest rate on your outstanding balance. Also, your credit score will be negatively affected as most banks will report late payments to the credit reference bureaus.
- Making the minimum monthly repayment only: The minimum monthly repayment is the amount you need to pay on your credit card to be in good terms with your lender. The reasoning behind this is to make it easy for the card holder to make small affordable payments. While it is a good idea, it is not advisable for you to pay the monthly minimum, as it will make your debt more expensive due to interest costs. Usually, if you pay more than the agreed monthly limit, you can reduce the time to settle the full amount by 50%, and your interest costs will fall drastically. Therefore, paying more than the agreed monthly limit is a smart move.
- Closing your credit card account once you have paid the debt balance: Once you have completed paying your credit card debt you may decide to close your account with the bank, however, this is not a good idea for two main reasons. First, your credit cards establish a credit history which is important if you are going to build your credit score so as to borrow larger amounts in the future. Secondly, paying off your credit card balance lowers your credit utilization ratio, which also enhances your credit score.
- Obtaining the wrong credit card: Credit cards are tailor-made to address different credit card needs, such as credit cards for making large purchases, credit cards used to prevent carrying cash during travel, credit cards for shopping for household goods and items and so on. Ideally, you should use your credit card for budgeted and intended purposes.
Having a credit card is a serious responsibility, therefore new card holders should begin slowly, and spending on what is absolutely necessary and affordable, and getting into the habit of making debt payments on time. Having a budget can also help you to better manage your credit card use.
If you do get into credit card debt, managing it can come in a variety of forms. The options available to each individual are usually dependent on their own financial circumstances. However, by monitoring the use of your credit card, and applying sound financial principles you can pay off your debt and be on the path to financial freedom.
What is your take on credit cards? Have you experienced any of the above mistakes? Let us know what you think by commenting below.
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