Beware of the Credit Card Debt Trap

You must have heard of the quote “Rather go to bed supper less than rise is debt”, by Sir Benjamin Franklin. This famous quote just gives an indication to the extent of troubles that one might invite if debt is not managed properly.

One of the most common types of debt among our urban class is Credit card debt. Let’s try to understand how one falls into the debt trap.

Sumeet, 26 had gone along with his friends for pre- Diwali shopping at one of the local malls and during the course of a few hours ended up blowing up a couple of thousands which was way beyond what he had planned for. All his purchases were done by credit cards as he did not hold that much cash in his account. When the credit card bill came in next month, he was comforted by the fact that he could make a minimum payment of close to 5% of the outstanding amount and pay the rest in the following month. Little did he realize that he would have to pay an interest on the outstanding at the rate of 3.5% per month (42% annulised). In the interim, Sumeet added a few more debts by purchasing some electronic items and dining at some of the posh restaurants with friends. Sumeet never saved enough to pay back the entire credit card debt and in a few months his debt and interest outgo reached such a level that he started skipping even the minimum amount due. The final nail in the coffin was when he started getting hounded by calls from recovery agents. Had it not been for his father who settled the entire outstanding with the credit card company, Sumeet‘s life would have become miserable.

Even young married couples too fall into the credit card debt trap and by the time they realize, it’s too late.

How does one avoid this pitfall? There are 5 steps you can take to avoid landing yourself in such a situation.

o   Maintain a monthly budget.

o   Maintain a contingency fund

o   Always use your debit cards

o   Maintain a credit card only for emergency.

o   Pay your credit card bills on time

o   Don’t keep more than one credit card

Maintain a monthly budget

This is the first thing which should be done and followed diligently. Prepare a simple cashflow statement of inflows and outflows so you are aware of the possible expenses and surplus (if any) that is generated every month. If there are no surpluses then you can take a hard look at the possible expenses and try to rationalize them and generate surpluses for savings. This exercise will also help you to plan any high value purchases in advance.

Maintain a Contingency Fund

A contingency fund equal to 3 -6 months of your monthly expenses should be maintained in your savings account in order to fund for contingencies such as a hospitalization or loss of job. This fund will enable you to meet the unforeseen expenses and prevent you from borrowing. For example if your monthly expense is Rs. 25000, then you need to maintain at least 75000 in your savings account for contingency purpose.

Always use your debit cards

Usage of your debit cards will keep your purchases under check and you will spend within your means. You will be more disciplined towards your purchases and avoid falling into the credit trap.

Maintain a credit card only for emergency

Credit card has its own advantage too. Given a situation when your family member faces a medical emergency and has to be hospitalized at odd hours, you might not have access to cashless mediclaim or an ATM at that time. The credit card comes in handy in order to pay the initial deposit. But make it a point to pay back the amount within the first payment cycle.

Don’t keep more than one credit card

Nowadays we are bombarded with hundreds of calls from banks to take up a credit card with promises of no membership charges for lifetime. Do your due diligence on the various possible charges including the membership fees, late payment charges and interest rates charged, before signing up for one. Having more than one card will always provide the temptation of making purchases beyond your paying capacity.

Pay your credit card bills on time.

Please remember the credit card debt is the most expensive debt among all categories of debt. The annualized percentage rate can be as high as 42 %.Most of us fall into the credit card debt trap when we fail to pay the credit card outstanding bills and continue paying the “Minimum Amount due”. This results in the company slapping us with late charges penalty and interest on out standings.

Please remember that it’s easy to get into debt but difficult to come out of it.