Credit cards have features similar to personal loans, but it's a mistake to treat a credit card like one.
With just a swipe, a wave or a few button taps, credit cards let you pay for the things you need. You then wait for your credit card statement and pay off the amount you’ve incurred on your card.
If you’ve been paying off your bill in full each time (good job, keep it up!), you might have started thinking of your credit cards as a part of your personal financial assets, like the money in your bank account.
But if it is true that your credit card is equivalent to your money, why are you billed every time you use it? Afterall, you don’t find yourself getting a bill when you pay in cash.
If you didn’t actually use your own money to pay at the point of purchase, then who paid for it? Are credit cards a loan?
Technically, Credit Cards Are A Loan
The short answer: Your bank paid first on your behalf, then billed you for the outstanding amount.
When you swipe your card, you’re provided with the funds you need at the point of purchase. You’re then given approximately 25 days to pay off what you owe, without interest.
After the interest-free period, any amount that is still outstanding will be subject to interest charges. You will be charged according to the base rate attached to your credit card - usually around 25% per annum.
So strictly speaking, credit cards are a type of loan. There are also other features that make credit cards resemble loans.
For one, credit cards also come with a cash advance facility, which lets you withdraw cash from an ATM, up to the current credit limit on your card. Note that cash advances come with upfront fees, and the interest on the amount you owe is higher than your credit card’s base interest rate.)
Your credit card also allows you to pay for big ticket items at partner merchants using a monthly instalment plan.
But Credit Cards Work Differently From Loans
However, credit cards work differently from other credit facilities like personal loans.
One of the main differences is the interest rate. Credit card interest rates typically start around 24% to 25% per annum, and under certain circumstances, may be raised to 29% or thereabouts. Personal loans, however, offer much lower interest rates of between 5% to 8% per annum.
Another difference is the relatively short interest-free period. When you put a purchase on your card, your bank or credit card issuer waits for a period (usually between 21 to 30 calendar days) before charging you interest on the amount you owe. Contrast that to a balance transfer, which offer interest-free periods ranging from 3 to 12 months.
A third major difference is that cards provide you with rewards and privileges. For example, you can earn KrisFlyer miles for free plane tickets and flight upgrades, and enjoy perks like complimentary travel insurance. Conversely, you barely get any rewards for taking on a personal loan or balance transfer.
Don’t Use Credit Cards As A Loan
You shouldn’t use your credit card as a loan for 2 reasons: the short interest-free period and high-interest rate.
Carrying a balance on your card, or using it to get a cash advance, will stick you with high-interest charges that compound at between 2% to 3% each month. That may sound like a small amount, but compounding interest means that interest is charged on top of any interest that you owe.
So if you’re not careful, you can find yourself struggling just to keep up with the minimum payments every month.
Therefore, if you happen to be in need of a loan, it’s far better to apply for a personal instalment loan, or a balance transfer. The lower interest rate and longer interest-free period will help you pay back the loan in a timely and manageable manner.
Use Credit Cards For Convenience And Rewards
When used correctly, credit cards are beneficial and rewarding.
Your credit cards offer convenience, allowing you to make purchases without the need to lug around bags of cash. With interest-free periods that last almost a month, credit cards can also be safely used to provide short-term liquidity.
Perhaps the most attractive reason to use credit cards are the privileges and perks they provide. Therefore, your main reason for using credit cards should be to benefit from rewards.
Just remember to always pay off your bills on time and in full, so you can continue to reap those air miles, reward points and cash rebates.
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By Alevin Chan
A Certified Financial Planner with a curiosity about what makes people tick, Alevin's mission is to help readers understand the psychology of money. He's also on an ongoing quest to optimise happiness and enjoyment in his life.