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From the Rat Race to Financial Freedom... A common man's journey
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Sunday, May 25, 2014

Credit Cards Vs Debit Cards

On the journey towards financial freedom, i strictly recommended in my book (From the Rat Race to Financial Freedom) that Debit Card is the only way for a freedom seeker. Credit Card will always lead you to spend more, even if you manage to stay out of its debt trap. At the same time, many readers came back to me asking how do we have a win-win wherein we can en cash the benefits of both the credit cards and debit cards... Read on...

Credit Cards do have their advantages. But remember that all these advantages are incentives for you to get in the trap of more spending and worse, into a debt trap, wherein you are unable to pay the outstanding bill amount before the due date. The entire western economy is based on spending, and we can see how hollow this can ultimately turn out to be. 

But if you are truly a "mature" investor, and have demonstrated your maturity by tracking and controlling your spending over the last 5-6 years, then you can try your hand over a credit card. There are some distinct advantages that a credit card can give you. 

Having said that, there are two points of caution that you must adhere to, before continuing to use a Credit Card for more than 6 months:
1) Monitor your expenses and see if there is a spurt in expenses that you are seeing vis-a-vis your previous 6 months (when you were not using the Credit Card). General thumb rule is that any expense increase more than 10% within 6 months is a spurt. If you need help in tracking your expenses, you can log in to the Freedom Portal to download the expense tracking sheet.
2) If you feel uncomfortable or are unable to pay 100% of your credit card outstanding bill before the due date, this is a serious alarm to switch back to the debit card mode.

Distinct Advantages of Credit Cards
If you can manage to win over the above two scenarios and continue to monitor these scenarios for 6 months and more, here are the unique Credit Card benefits that you can avail of
    • Debit cards charge annual fees and issuance fees. Credit cards can prove to be cost effective in this space. These debit card charges may not be applicable if you are a privileged customer for a bank.
    • Debit card doesn't help in building credit score whereas credit card does. Establishing a higher credit score will not only help you bag softer interests and insurance rates, but also get you quicker loans and preferential treatment. Using a credit card wisely is the best way to build a good credit history. Read more about the Credit Score here.
    • You can impose a limit on your credit card, which is far lower than the sanctioned credit limit. This will help regulate spending and reduce liability in case of a fraud
    • Unlike in a debit card, you pay your credit card bill at the end of the billing cycle, so your money continues to earn interest in the bank for the additional days every month.
    • Aggressive card-users can earn more rewards on a credit card, like free air miles for frequent fliers and free stays for those having a co-branded hotel credit card.
    • Both credit and debit cards are protected against fraudulent use by the zero liability scheme. However, you still have to take steps to keep your cards safe and this is easier with a credit card. You can impose a limit on your credit card, which is far lower than the sanctioned credit limit. This will help regulate spending and reduce liability in case of a fraud. There is no such facility for a debit card. Also, with a credit card, you don't have to pay the disputed charges till the issue is resolved. In case of a debit card, while you may get your money back within 60 days, in the interim period, your reduced bank balance may cause other transactions to default, leading to substantial penalties.

If you have a credit card that does not incur an annual fee and you use it smartly (read, never revolve credit and pay bills before the due date), it works out cheaper than a debit card and can also help you build a good credit score.
However, if you want to keep your life simple, Debit Card is the way,

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