If you are a Gen-Z investor and spender, you may not have a good credit score, simply because you may not have availed of any credit line until now. A bad credit score or low income makes it difficult to obtain a credit card or the credit limit that you may be hoping for.
One of the ways to get around this problem is to go for fixed deposit (FD)-backed credit cards. The FD here acts like a collateral, on the basis of which banks agree to issue a credit card.
But before going in, know what these cards are and what are the risks attached. Once you have a handle on that, make the most of FD-backed credit cards.
These are special types of credit cards that come with certain predefined collateral conditions and other terms. To get the credit card, you would be required to open an FD with the issuing bank. The credit limit of FD-backed credit cards is usually around 80-90 per cent of the FD amount.
However, you will continue to earn interest on the FD as per the specified interest rate and tenure. The FD will keep getting auto-renewed until you surrender the credit card issued against it.
Banks usually do not check for income security or credit score when issuing these credit cards as they are fully secured against the FD.
“People with no credit score (due to no past credit history) or a low credit score (due to poor credit repayment history) find it difficult to get a credit card. Opting for an FD-backed credit card i.e. a secured credit card allows them to start building and fixing their credit score. While the underlying FD ensures that it continues to earn interest, it acts as a security cover for the banks. On the other hand, the risk of losing the FD acts as a reminder and makes the customer manage their overspending,” said Amit Das, co-founder and CEO, Think360.ai, a full stack data science and artificial intelligence focussed company.
Credit cards can ease up transaction, but it also entails the risk of falling into a debt trap if you are not judicious enough. That’s because it’s an expensive form of debt and non-payment can land you in trouble. The interest rates on credit cards could be as high as 20 per cent or even more, depending on the issuing bank.
“Credit cards and personal loans are typically the first line of credit that banks offer to eligible customers. Availing and using unsecured credit is easy. However, timely repayment is critical. If you repay your dues on time and in full, your credit score starts to develop. If you are late with payments, the score falls,” says Adhil Shetty, CEO, BankBazaar.com.
Remember that while you use the credit card, you won’t be able to use the FD as it will be under lien. Also, if you are irresponsible about how you spend, you will be putting your own deposit at risk. In case of a credit default, the FD will be terminated, and the bank will recover the dues and return you the balance, if any.
Credit cards are a good and easy way to build up a nice credit score, which is essential to apply for a loan. “FD-backed credit cards assist in building credit history as evidenced by disciplined usage. A decent credit score will enable access to loans and other forms of credit, that too at advantageous terms,” says Raj Khosla, founder and managing director of MyMoneyMatra, a loan aggregator.
Unless you have a credit history, lenders may be reluctant to give you money, which may pose a problem in the future when you apply for education or home loans. “Today, loan rates are linked to your credit score. If your credit behaviour has been good and your payments are on time, you can take more loans at lower interest rates. But if your score is low, your loan rates will be higher. In extreme cases, you may not get the loan at all,” says Shetty.
A lot of students and young professionals may not have ready cash lying in their bank accounts for emergencies. Credit cards can come in handy in such situations. But again, experts advise that you should ensure the repayments are done on time.
An FD-backed credit card could be used only for emergencies while ensuring that your FD keeps paying you some interest.
Many FD-backed credit cards have a relaxed repayment period ranging from 30 days to up to 50 days. Use this option to break down big purchases by spreading the amount over two months. For example, if you need to buy a laptop worth Rs 30,000 for yourself, you could repay half the amount in the first 20 days falling in one month and settle the rest next month within the repayment deadline.
But remember to plan well so that you don’t overshoot the repayment deadline.
This is one of the primary advantages a credit card has over a debit card. You can get reward points for shopping using a credit card which can be redeemed later for other purchases or in the form of cash in some cases. You may use the credit card to fund your daily purchases offline or online and get rewarded for doing so. However, be extremely careful and do not overspend.