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Personal Finance: Credit or Debit Card?

Personal Finance: Credit or Debit Card?

By Sidharth  Prusty

Edited by, Anandita Malhotra, Senior Editor, The Indian Economist

People have long debated the pros and cons of using credit vs. debit cards for personal expenditures. This article attempts to look at both sides of the coin and tries to come up with a solution to optimally use both of these cards for a productive expenditure plan. Let us first analyse the functions of both these cards.

The Debit card is simply a payment card which provides the cardholder the right to electronically access his savings with a financial institution. It is normally linked to a savings/current account and is readily issued to an account-holder. On the other hand, the credit card is a little more complicated system of payment. It allows a cardholder to pay for goods and services based on his/her promise to pay for them later. Unlike debit cards, it is not linked to any particular account and is issued after assessing the credit risk (the chance of default) associated with an individual. It is also associated with an annual fee, late fees and interest on debts if the payments are not made in time.

So, conventional wisdom says that if we have a somewhat comfortable income and are able to make ends meet, then a credit card is simply a burden, right? Wrong!! Well, let me explain with a real-life example. Suppose Mr. A is our average income guy who has no credit history or insurance. He has a stable income which allows him to live comfortably along with his family. Now suppose he wants to move out of his rented apartment and buy a new house. He doesn’t have the required savings to purchase it on his own. So, he goes to a bank for loan assuming he would get one easily. Imagine his surprise when the bank chooses not to approve the loan. What went wrong?

The fact is banks have many ways of measuring the credit risk; and one of the most widely-used is credit history (measured with parameters like credit score and credit report). Credit history is the record of an individual’s past borrowings and repayments, including information about late payments or loan defaults. The reason why it is so appealing to banks is because it helps them to assess the repayment capability of a person. And a credit card is a very good way to build your credit history. What is more is that most credit cards offer huge bonuses (e.g. Air Miles), discounts and cash rewards for the money consumed. It is a much more secure form of payment as compared to a debit card. What’s surprising is that even employers sometimes look at the credit history of an individual before hiring!!

But the credit card system is not as rosy as it looks. For example, a credit card company can charge exorbitant rates of interest on late payments, as high as 25%; much higher than the market rates of 5-6%. Moreover, many argue that credit card makes the cardholder overspend. A Debit Card is better in this respect because all the transactions can be seen in real-time and hence one can easily keep a track on his spending, hence curbing the unnecessary spending. Moreover, if you do default on your credit card payments, it adversely affects your credit history.

We can clearly see that both the cards have their own benefits and disadvantages. So how should one go about spending with both of these? Probably the best way is to analyse your own situation and come up with a plan of expenditure. The plan should be feasible and take into account your capital inflows and outflows, and how each card will fit into your own spending plan. It is important for a plan to be practical so that one can stick to it easily. For example; for a stable income person, it may make sense to use the debit card for everyday payments like food, fuel, general accessories etc. and use credit cards to make one-time payments like repairing work, holidays, or even for buying new furniture. This is because one-time payments may drain a person’s meagre savings but paying through a credit card gives him more time to arrange for the money. And obviously there is the added advantage of cash rewards and building credit history. But it is very important not to default on your payments. The credit card companies want us to default in our payments so that they can extract money from us. But the benefits of credit cards are plenty and hence they can’t be written off as well.

Hence, it is up to us to be sincere in our personal finances and hence reap the benefits of both these cards. An individual should properly plan his earnings and expenses and come up with a way to use both the cards effectively. To conclude, we can safely say that the best use of the credit and debit cards will surely make an individual financially secure in the long run.

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