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Beginner’s Guide to Credit Cards 1: Introduction and Dangers

Author
Baizat Team
Category
Credit and Loans
Tags
Credit Card, Banking, Tips, Debt, Risk Management, Pitfalls
 

Planning on getting a credit card for the first time? Unsure about how they work? The Baizat series: "Beginners Guide to Credit Cards” will guide you through the basics of Credit Cards—the good and the bad.

 

Introduction and Dangers

Nearly every person we know will, at some point in their life, own a credit card. They are a major part of society and you will see them advertised everywhere, including on TV, in malls, on billboards and on the internet.

In Part 1, we introduce the basic functions of credit cards and their dangers.

 

The bank’s money

Credit cards are issued by banks or credit card companies; they permit you to make purchases or pay your bills without using physical cash. Instead of using your own money, you are using the bank’s money.

Depending on your earnings and status, the bank will allow you different limits on what you can spend. You should never take a card with a limit higher than your monthly salary, even if your bank will allow it.

 

Paying back the bank

The most important benefit for many people, is that you get a grace period of 20 to 50 days (depending on the billing cycle) to make your payment after you use the card. So if you do not have the money to buy something you can buy it immediately with your credit card and pay for it later.

You should always pay back what you owe fully within this grace period, or you will start to incur charges. These charges present a big danger when using credit cards!

 

Dangers

If you cannot make your full payment within the grace period, there will be a minimum payment that you need to make. The minimum payment may be around 5% of your purchase, but you should always check this with your bank.

What happens if I make my minimum payment, but not the full payment?

This is where banks make a profit from the money you owe. Interest (a percentage of the money you owe) will be added to your total to pay back. Interest may be 2.99-4% of what amount remains to be paid in your account. No matter how little of the bill is remaining, this interest will be charged.

For example, you just make your minimum payment:

  • 1. You buy a computer for 3,000 AED with your credit card.
  • 2. You only pay back your agreed minimum payment of 5% (150 AED) in your 20 days grace period.
  • 3. When you pay the 150 AED minimum payment, this leaves you with 2,850 AED to pay.
  • 4. But it’s the end of the grace period! Your agreed amount of interest, for example 3.5% will be added to your remaining amount, this is 99.75 AED.
  • 5. So your remaining amount to pay rises from 2,850 AED to 2,949.75 AED. Very close to the original amount!

What happens if I do not make my minimum payment?

This is where banks make an even bigger profit from the money you owe them! If you do not make your minimum payment, for example 5% of the total owed; then they will also charge you a late payment fee on top of the interest as above.

For example, you cannot afford your minimum payment:

  • 1. You buy a TV for 4,000 AED with your credit card.
  • 2. You do not meet your minimum payment of 5% (200 AED) in your 20 days grace period, and only manage to pay 100 AED.
  • 3. This leaves you with 3,900 AED to pay.
  • 4. But it’s the end of the grace period! Your agreed amount of interest, for example 3.5% will be added to your remaining amount, this is 136.50 AED.
  • 5. So the remaining amount to pay rises from 3,900 AED to 4036.50 AED.
  • 6. But remember? You didn’t meet your minimum payment, so you will also get a late payment fee, for example 150 AED.
  • 7. This puts your amount owed up to 4186.50 AED - more than the original cost of the TV! Plus the 100 AED payment.

Important tip: Always be sure you can afford to make your payment within the grace period. Do not let interest and late payment fees take over your life. A credit card is never an offer of free money; it is a liability and a big responsibility that you are taking to pay back on time.

 

Continued in Part 2…

To learn about the benefits of credit cards, and how you should shop around for the right card for you – read the next part of our "Beginner’s Guide to Credit Cards”series.

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