To understand which credit card to take requires us to understand how credit card companies make money from the 2 main components of its network – users and merchants.

Users

1. Credit card companies provide a 25-30-day credit free period to customers within which customers can make purchases using the credit card. Users use the card as an interest free source of borrowing.

2. Using a credit card is also more convenient as it does not have the same cumbersome elements of using cash – that is, there are no issues stemming from managing change, security etc.

3. After the credit free period, an interest is charged if the customer does not pay off the total amount spent in that period.

4. Sometimes customers are also charged an annual fee for using the credit card.

Merchants

1. When we purchase items at a store using a credit card, then the merchant pays around 2-3% of the transaction value to the credit card company. In the case of most merchants this additional 2% is not passed on to the consumer, i.e. by using your credit card one doesn’t have to pay 2% extra.

2. The reason why a merchant agrees to pay 2% is for two reasons:

a) Without a credit card the merchant will incur costs of around 2% of transaction value due to cash management activities, pilferage, etc.

b) Studies have indicated that having a credit card increases the propensity of customers to shop

The main costs for Credit Card companies are fees paid to interchanges (such as Visa or Mastercard) and to the banks of the Merchants.

Now let us understand why customers should have credit cards and how should these cards be used.

1. Customers should use credit cards because it provides an interest free loan for a 25-30-day period. Instead of paying cash upfront for purchases during this period, customer should instead let that cash be in an interest earning account. While the interest earned over a 25-30-day period may seem small, it adds up over months and years over which the credit card is used.

2. Most credit card have a loyalty based points system. These points when monetized effectively return 1-3% of the total spend on the credit card. Therefore, its like a discount to all your shopping bills. Once again, these discounts add up over the lifetime of expenses and this becomes a significant saving.

3. Credit cards provide convenience over using cash as there are no issues related to managing currency and change. However, customers should periodically review their credit card statement to ensure there are no losses due to fraud.

4. Customers should take a credit card because  of the other monetary benefits that they offer. Credit cards are designed to offer different types of needs of various customer segments. Some of these types are mentioned below.

a) Some cards are designed for frequent flyers. Card companies offer these cards to wealthy individuals and consider lounge access a marketing cost to acquire these lucrative customers.

b) Cashback cards: these cards provide cashbacks through loyalty points in the credit card’s system. These cards can lead to significant savings. We highly recommend individuals to have at least on such card

c) Partnership cards: These cards tie up with certain brands. Customers get benefits such as higher cash backs when the card is used to make purchases with these brands. These cards are recommended if the customer makes significant purchases from these brands

d) Benefits cards: These cards offer a range of benefits including health club access, gym access, travel related benefits

5. Credit card statements are a good way to analyze one’s expenditure profile. One should regularly go through the statements and review the nature and recurrence of spending behavior.

6. Credit cards provide immediate access to a credit facility. This is important in times of financial emergencies.

 

Disclaimer: Vitspan does not provide any investment related, tax related or financial advice. The information presented is done so without considering the investment objectives, risk profile, or economic circumstances of any reader or investor. The information presented may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the potential loss of principal. Please consult your financial advisor prior to making investment related decisions.