Why I hate Credit Card

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I have always been wary of using credit cards for any transactions. Secuirty is one major aspect which actually pushes me to the limit of having a phobia of using credit card for any transaction. Here is a simple example of why I fear so much. When yesterday I wanted to change my billing address of one of my credit-card from a top Indian bank, this is the procedure I had to follow :

- Call up the customer care (I dont know who is sitting there. Is he a employee of credit card company or just a call-center employee)
- Answer all the queries from the other side which mostly involves personal information (Who stops the person at other side form mis-using that information)
- It is upto the discretion of the person at other end to go into how much details for getting to know the personal information (which he probably verifies, indicating that he already has access to all my personal information including the transactions I made). The idea behind this is to verify your identity. I still cannt believe that technology has not made such a progress as to eliminate this middle man. I should be able to change my address through some more secure way without any middle person.

Anyway the other reason I fear using a credit card is the way credit card companies try to extort money out of poor consumer with legal means. Most of the time it is usually a financial burden while using credit card than the comfort and convinience of using it. There is a phenomenal rise in the number of credit card users in India, because people find it easy to get money on credit (as high as few lakhs ruppees, no question asked) and the convinience of using it (no paper work, no queues to withdraw money, no hassels) and along with the claim of security the credit card companies proclaim (you dont have to carry cash, and if the card is lost just a single call to the customer care will prevent its misuse). But most of the people, espeically in India, and unaware of the fine print in the rules and conditions along with the smooth way credit card companies dupe the consumers.

It is probably one of the most profitable business for the banking institutions. I want to just clear some of the points which might take away some of the sheen of using a credit card and put some reality and insight into this whole business.

The money you get from credit card is similar to a loan just a bit more sophisticated. If you spend 50,000 Rs with your credit card today, essentially you took this money from the credit card company. So obviously you have to pay an interest on that loan. This loan (the money on credit you took) does not require you to submit any documents (as a normal loan would) or to prove your credibility. I remember that when I applied for a credit card, I did not reuired a lot of documents to submit. It was usually just fill up a form and submit the latest pay-slip. So a credit card company doesnt have much information about their customers and the risk of defaulting on loan is much higher. Someone can spend few lakhs using a credit card and actually vanish, and the credit card companies cannt do much. So obviously this loan is much riskier than any other loan. This compels the card comapnies to charge a much higher interest rate. This can be as high as 42% annually (thats what my credit card statement says).

Here is an interesting aspect about "
interest on outstanding balance". Almost every credit card company allows you to repay the loan (the balance) on a revolving credit basis. This is a extremely fine trick. So assume this month you spent 10,000 Rs through your card and when the statement comes, the company asks you just to pay back the "minimum amount due". This could be as minimum as 500 Rs. Assume that the company levied say 5% interest. So with a spending of 10,000 Rs, the outstanding balance is 10,000 + 5% of 10,000 (500Rs) + service tax (12% = 1200Rs). Let us assume no other charges (I will talk about other charges later on). So the total outstanding balance is 11700 Rs. Now you paid back Rs 500. So the next month, the outstanding balance is 11200 Rs. When the next month statement comes, you can see that the 5% interest is applied on 11200 Rs.

How can someone justify this 5% interest on the entire outstanding balance. The loan you took was for 10,000 Rs, out of which Rs 500 you paid back. So the 5% interest should be charged on 9500 Rs. But it is also charged on the previous interest and service charge you paid along with any other fees. What essentially is happenning is a compunding interest rate, which really can grow to an exhorbitant payback to the card company. The best way to kill this compounding is to NEVER use the revolving credit.

Let me tell you first of few terminologies:

Purchase Date --> Date on which you used the credit card for some purchase.
Billing Date --> Date on which your card company creates the bill.
Staement receive Date --> Usually the date when you receive the statement
Last Payment Date --> The date when you are supposed to pay the bill.

Grace Period = Last Payment Date - Purchase Date. This is essentially the point when you took loan (purchased something) and the date after which you will be charged interest and whole assortments of fees. This is an important period to use the card optimally. I will discuss this later.

Credit card companies also charge an assortment of lucrative fees.

Late Payment Fees: This is one fee I hate to pay. I have paid it many times and usually it is usually very high like Rs 500. A credit card company can even charge this fee if your payment is just a single day delay. Worse, the credit card company may determine that you have borrowed your entire outstanding balance from the time of purchase until the time of payment, eliminating the "grace period".

Annual Fees: This is a charge just to keep your card active. A simple straight gain for card companies.

Cash Withdrawal Fees: Some card companies has the facility to withdraw cash from ATMs using the credit card. There is usually some fee attached to it.

Balance Transfer Fees: Now a days I have seen some card companies urging customers to transfer the balance on any of their other credit cards to this company card with the benefit of low interest. They might apply some charge for this transfer.

Imagine the amount of money you have to shell every time you use the card. This is not the only charge. The credit card company will also charge the shopkeeper (something like 2%) for any transaction made. The shopkeeper pushes this 2% charge to the end consumer. Whenever I want to purchase anything from some shop, the shopkeeper will tell me that I have to pay the 2% extra if I plan to use the card. So at every point you as a consumer has to shell out money.

Prospect Theory

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Which of the following investment options you would choose:

Stock A at Rs100 has a 7% chance of dropping below Rs100 in the next five years.
Stock B at Rs200 has a 93% chance of gaining from this price level in the next five years

I was reading an interesting theory which explains the human psychology in making decision as the above question. It is called prospect theory.

The theory tells that while choosing between the two options your mind executed two operations:
  • Editing
  • Evaluation
The editing phase is preliminary analysis of the offered prospects while the evaluation phase is when the prospect with the highest value is chosen from among the edited prospects.

In the first, the different choices are ordered following some heuristic so as to let the evaluation phase be more simple.

The value function (sketched in the Figure) which passes through this point is S-shaped and, as its asymmetry implies, given the same variation in absolute value,
there is a bigger impact of losses than of gains.

This loss aversion refers to the tendency for people to strongly prefer avoiding losses than acquiring gains.

I hope you have seen through the quiz posted above. Both the options indicate same thing. A 93% chance of gaining is equivalent to 7% chance of dropping.

Reverse Mortgage

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I talked about having a scheme for banks to provide money on the house I own. It seems someone has heard it. The National Housing Bank has launched a new scheme called the reverse mortgage through which you can get the money for your home that too without selling it.