Credit Card Caveats
You hold your card up. It shines in the light, just like how you feel your future will be. A smile forms across your face as you figure out your next online purchase on your favourite shopping portal. Or that flight ticket you’ve been eyeing for a while now.
What could go wrong, you think to yourself? Your optimism is second only to the smugness you feel. It also helped that you obtained a free hotpot from signing up for the card.
While you might feel like this at first:
But if you’re not careful, there’s a chance you might end up like this:
In a report released by the Credit Bureau Singapore, there was a 32% increase in the number of credit card customers who have two months or more of their credit card debts past due, compared to the number of those customers in 2011. And on average, each of them owes a staggering amount of $3380. Bear in mind, this is just an average so there are others who owe way more.
The pros of using credit cards are already widely trumpeted. That said, we feel that we should also discuss the cons of using credit cards. In our love for alliteration, we decided to call them credit card caveats.
Biting Off More Than You Can Chew, or Overspending
The threat of overspending is very real. One thing people forget when they use credit cards is that they’re borrowing money. They still have to repay at some point later on. It is definitely psychologically less painful to swipe cards than to hand over the physical cash. In other words, credit cards numb the pain of purchase by delaying the payment. This behaviour can be dangerous when you don’t keep track of your expenses, and maintain only a rough idea of your purchases which will lead to expenses rolling out of control over a period of time.
Credit cards affect us in ways subtler than we can imagine. An often cited psychological research by Feinberg in 1986 suggested that consumers tend to overestimate the price of goods with credit card logos. This study was replicated over various locations over the years, each study yielding similar conclusions.
In a study by Prelec and Simester in 2001 on credit card behaviour on purchasing, they found that subjects were willing to spend as much as twice the amount of money when using credit cards on consumer products compared to using cash (this behaviour was found in debit card users as well in a separate study by Runnemark et al).
Research also suggests that the credit limit a user has in his/her credit card makes purchases seem less significant. For example, let’s imagine you see a $3 bar of chocolate which you are really keen on eating in a candy shop. You rummage through your pocket and you find only $5 in your wallet. It is most likely that you’d think twice about buying it if that’s the only money you have at the moment. What if you find your shiny Mastercard instead which has a credit limit of $5000? Chances are you would be more likely to purchase the candy bar with the credit card than if you had the cash alone.
What can we really do to counteract this? Unless you are Swiper from Dora the Explorer, you should be conscious of your (credit card) swiping. Take more time to do research on your purchases, i.e. sleep on it before deciding on a purchase. On top of that, keep track of your expenditure – there are apps out there which can help you monitor your expenses like Expensify, Wally, Pocket Expense, etc.
The Devil is in the Details, also known as Hidden Terms
If you purchased anything while you were overseas, you might want to take a reaaaally close look at your transactions. Your statement might have some discrepancies and it isn’t the currency exchange rate that caused the discrepancy. Perhaps a quick look at the terms and conditions of your credit card might help.
There are three forces at play when you spend overseas.
Firstly, it is the foreign exchange rate of the country you made your transactions in. For some cards (we won’t say which), foreign currency transactions other than USD transactions are converted first to USD before being converted to SGD. This arrangement exposes you to two different foreign currency markets, which may end up costing you.
Secondly, the card associations impose a currency conversion charge whenever you spend overseas. This can be around 0.2-1%, depending on whether you go with the standard transaction or dynamic currency exchange (some merchants offer this).
Thirdly, on top of that, depending on your card association (Visa/Mastercard vs Amex), the bank charges you a 1.5-2% administrative fee. Thus, in total we’re looking at an average of 2.5% on top of the currency exchange conversion mentioned in the first point.
Let’s Do Some Maths
In theory, that sounds okay. What’s 2.5% on top of currency exchange, you think to yourself. Let’s crunch some numbers. Assuming you’re in Japan. You’re holding a DBS Credit Card, and you decided to use it to buy a bag in Shibuya. The bag costs 50,000 yen. The merchant accepts Visa, and so you swipe. The amount is first converted to USD and then to SGD, and then a 2.5% charge on top of the converted amount.
Oh boy, you spent extra $15 swiping a card. We tested numbers with varying sums across different countries, and the conclusion is similar – even if the currency is favourable to you, the gain is balanced by the 2.5%, which results in spending more. We would like to caution you to weigh the pros and cons of using a card. We’re not entirely against using cards, of course. Cards are definitely useful when you are in an unsafe country, where carrying cash is definitely riskier. On the other hand, you too must be conscious of the transaction fees.
Another hidden term which we would like to highlight is the “interest-free instalment plan” that comes with some of the credit cards you signed up for. It’s true that you are able to make 0% instalment plans on these cards, but there are several things you have to bear in mind when using them.
Let’s say you decided to buy a $3000 laptop (a bit pricey, but bear with us here), and charged it to your credit card under the 0% instalment-free plan. If your credit limit on the credit card you used was $4000, it means you have $1000 credit limit remaining for the card which returns gradually as you make payment.
Another thing to note that is you will be charged for the purchase via administrative fees, which can range from 1-6% depending on whether the shop is a participating merchant. If the best case scenario, your laptop purchase increased to $3060 and in the worst it is $3180. Cancel your plan halfway, and you pay even more on top of what you need to pay for the remainder of your instalment. Try to pay more early in an attempt to clear your instalments faster, and you get charged too (it’s called prepayment in the Terms and Conditions so make sure you ask about your bank). In summary, there is no such thing as a free deal and you have to be cautious in order to maximize this arrangement.
Credit Cards (Somewhat) Affect Your Future
Credit cards are double edged swords. While credit cards can build your credit score for important loans, e.g., housing loans, in the future, they too can also harm your credit score should you fail to make your payments on time. But first, what are credit scores? Credit scores, according to Credit Bureau Singapore (CBS), is “a number used by lenders as an indicator of how likely an individual is to repay his debts and the probability of going into default. It is an independent assessment of the individual’s risk as a credit applicant”. It is a four digit number, ranging from grade AA to HH. AA indicates that the consumer is least likely to default on a loan while HH is most likely. In other words, this score is your financial street cred – it signals whether you’re a legit borrower or otherwise.
CBS then generates a comprehensive credit report based on your credit score using a number of factors. As you use credit cards, each repayment goes towards building up your reputation as a borrower under “Credit Account History”. Besides the extra payment incurred due to interest rates, the failure to pay on time is also reflected in the Credit Bureau Singapore (CBS) Credit Report. This is found under “Account Delinquency Data”.
An interesting factor which requires elaboration is “Enquiry Activity”. An enquiry refers to new application enquiries found on a credit report. When you want to take up a new loan or a credit card, your file receives an inquiry. Having a high number of enquiries (too many loans/credit cards) signals to the lender that you are trying to take on more debt. This can affect your score, because it implies taking on more risks. CBS advices readers to “limit the number of loan facilities and credit cards which you apply for”.
Ultimately, someone with a poor credit score will find it less likely (but not impossible) to secure bank loans in the future. If one bank rejects your application for a loan/credit card, it doesn’t mean other banks will do the same. Go to http://www.creditbureau.com.sg/credit-score if you are keen to know what are the factors involved in calculating your score.
We have come to the end of our article. While we have listed some depressing things, fear not! Please bear in mind that most of these caveats occur under unwise spending habits and not scrutinizing over the T&Cs of your card. As long as you keep these points in mind you should be a-okay.
So that’s it for now folks. Any more words and we might start losing your attention. Thanks for reading! Spend well, spend smart, and repay punctually. See you on our next post! Tell us what you think in the comments below!
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