How to use your credit card optimally

Couple purchasing online with credit card

Being safer than carrying cash, credit cards are a secure way of transacting, making online purchases, and tracking all expenses through a single facility. If not used optimally, however, a credit card can quickly morph into a debt trap and a source of financial anxiety. In this article, we answer frequently asked questions about how to use a credit card in your favour.

How does a credit card work?

A credit card is effectively a revolving loan from your bank that allows you to access pre-approved credit. Upon accessing the credit, you will be required to pay back the amount either in full at the end of the month or through minimum monthly instalments (or repayments). The interest charges on your credit card are set by your bank and are determined by a number of factors including your income, affordability, credit rating, your payment history and how much debt you have at the time of applying for your card. Remember, a solid credit score and a history of good repayments may help you negotiate a more favourable interest rate with your bank.

What costs are involved?

In addition to the interest rates attached to your facility, there are a number of other costs involved that users should be aware of, although these can vary between banks. Other costs may include a card initiation fee for setting up the credit agreement, monthly servicing fees, transaction costs, and fees for linking to the financial institution’s rewards programme. Some banks charge fees for cash withdrawals, spending over your credit limit, or when transacting abroad. It is important to read the fine print as the interest payable on some credit cards can differ for in-store purchases, point-of-sale purchases and ATM withdrawals, all of which can potentially drive up your usage fees. As such, it is important to calculate the total cost of your credit rather than looking at just one component of the fee structure, such as interest, in isolation.

How do repayments work?

At the end of each month, you have the option of paying the outstanding balance in full or paying a minimum monthly repayment. Naturally, paying off the full amount outstanding on your credit card at the end of each month is best as this will ensure that you do not pay interest on your purchases. That said, be sure to understand how your interest-free grace period works in order to take advantage of this benefit. Generally speaking, banks offer between 30- and 60-day interest-free credit, so it’s important to get the timing of your purchases and repayments aligned. Remember, if you only pay back the minimum amount owing each month, you will end up paying the maximum interest charges which is effectively the most expensive way of using your card and you may end up slipping deeper and deeper into debt.

What is the difference between straight and budget purchases?

When purchasing using your ‘straight’ facility, these purchases will be included when calculating the repayment owing at the end of the grace period. When purchasing on your ‘budget’ facility, you can select a period over which to repay the loan, for instance, six months or 12 months, but in such circumstances note that the interest-free grace period does not apply. Further, note that the interest-free grace period generally does not apply to cash withdrawals or fund transfers from your credit card.

What’s wrong with making the minimum payment?

Only making the minimum monthly repayments is the most expensive way of using your credit card as you will end up paying interest on the amount owed. The minimum payment is basically the smallest amount you can pay each month and is generally based on a percentage of the outstanding capital. Credit card interest is calculated on a daily basis and compounded every month, and this means that if you only make the minimum monthly payment you will end up paying interest on interest. That said, keep in mind that the maximum interest a bank can charge on a credit card is regulated to the repo plus 14%.

What happens if I don’t make my repayment?

If you fail to make your credit card repayments, the bank will report you to the credit bureaus and likely hit you with penalties or fees for late payment. Given the fact that your payment history accounts for 35% of your overall credit score, late payment can be detrimental to your credit rating which, in turn, can affect your ability to obtain financing in future.

How can I use my credit card to improve my credit score?

To use your credit card effectively so as to strengthen your credit score, you should ideally not use more than 75% of your credit limit and ensure that you pay the full amount outstanding each month. Having too many credit cards can also affect your credit score, and managing multiple credit facilities can be challenging, so ideally centralise your borrowing through a single credit facility. Further, before applying for a credit card, make sure that you are in fact eligible as too many rejections can also negatively impact your credit score.

Are the loyalty programmes linked to my credit card worth it?

If your credit card includes a rewards programme, it is likely that you are paying for the facility as part of your annual fees, so it makes financial sense to use the benefits. Programme benefits can include cashback rewards and vouchers, travel insurance, fuel vouchers, airport lounge access, free magazines, discounted Uber rides, and AA roadside assistance, although it is important to ensure that you know how to access and utilise these benefits to ensure that you get the maximum benefit from them. Be sure to fully understand how the reward programme works before signing up for it because many such programmes are designed to encourage expenditure on a ‘the more you spend, the more you save’ basis. If used correctly and with a full understanding of how the rewards programme works, it can make sense to move the money from your debit card into your credit card and use your credit card for all transactions.

Is a credit card good or bad debt?

If used correctly and within the grace period, you can use your credit card to make interest-free purchases with no transaction fees, although it is important that you do not use your credit card to fund your regular costs of living, purchase items that you have not specifically budgeted for, or to incur debt that you cannot service. If you need financing to cover the cost of studies, remember that a student loan is likely to provide you with more favourable interest rates and terms than a credit card. If there is a high-cost item you would like to purchase, consider rather saving up and paying cash for it rather than purchasing it on credit and paying it off over time.

It is evident from the above that a credit card can play a valuable role in building a positive credit history and establishing secure, responsible money habits if used strategically.

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