As the developed world moves towards a more environmentally friendly, sustainable lifestyle, it is reducing its reliance on plastic. Retail corporations like Tesco and even our very own Hyperstar are promoting the use of reusable canvas shopping bags. On the other hand, there is one plastic product that continues to grow in popularity – the credit card.
It is one of the most common ways people enter the world of personal debt. Yet, it isn’t quite as common in Pakistan as you might imagine. A survey from June 2016 conducted by Gilani Research Foundation (an affiliate of Gallup International) asked 1,813 men and women from across Pakistan a simple question: “Do you know what a credit card is?” The response? 53% said they did not know what a credit card was, while 46% said they did. Of course, there is always that 1% that does not wish to respond. Perhaps this should not be too surprising since Pakistanis are severely underbanked. Another research from 2016 reported that approximately 85% of Pakistanis did not even have a bank account!
It is generally quite difficult to get approved for a credit card in Pakistan. Banks tend to prefer salaried individuals, and many have a prescribed minimum period of continuous employment, for example you must have been working with your employer for 9 – 12 months when you apply. For self-employed individuals, most banks will require you to show very high bank balances, which might make you wonder why you need a credit card in the first place. Applicants are subject to the same credit appraisal as any other financing product. The bank will obtain your eCIB report from the State Bank and assess your credit history and any existing liabilities. Like any other loan, banks are not allowed to issue credit cards to individuals who have a debt burden ratio (DBR) of 50% or more (to learn more about DBR – see “Keeping Your Debt Burden Ratio In Check”). The impact of your credit card on your DBR is calculated as 5% of your credit limit.
Your credit limit is the amount of money you can spend on your card. The minimum amount payable every month is 5% of your outstanding balance or Rs. 500, whichever is higher. This rule applies to all credit cards across Pakistan. For DBR purposes, banks assume the worst-case scenario – that you max out any credit cards you have. Essentially, a credit card is a short-term loan that the bank provides you. This loan is interest free from the time you spend the money to the date the bill is due. Every month, you may choose to make the payment in full, or make the minimum payment. The minute you decide to pay only the minimum amount due, you enter dangerous territory. You expose yourself to the high interest rates that come with credit cards. Presently banks charge around 40 to 42% APR (divide by 12 to calculate the monthly rate). So, every month there is an outstanding balance left unpaid, you are billed “finance charges” of 3 to 4%. If you have racked up credit card debt that would take you months to pay back, it’s a serious problem – and it didn’t happen overnight. It started the very first time you decided to pay just the minimum amount.
Always pay your credit card bill in full every month. Credit cards should be used for their convenience and other benefits such as discounts, air miles, etc. and not as a tool to stretch your budget. It is borrowed money, not a source of income. You might wonder why banks extend such “interest-free” loans. Banks provide credit limits up to 4x your monthly income (usually for high income individuals); most people are allowed around the 2x income mark. You may have started to see the problem already. If you spend more than your monthly income, how are you supposed to pay all of it back the next month? You are likely to become what banks call “revolvers”. These are customers who carry a credit balance from month to month – and are the main source of the credit card company’s income. “Transactors” are those that pay off their credit card balances in full every month. Banks hope to have as many revolvers as possible, and try to convert transactors to revolvers regularly by offering larger credit limits. The first thing you need to do before you even begin to use your credit card is manage your credit limit. If the bank has offered you a high limit, ask them to reduce it. Don’t go beyond 1.5x your income. You might be the most disciplined money manager out there, but it is always better to avoid the temptation altogether.
From my personal experience, getting a credit card if you do not really need it at the start of your career can be extremely dangerous. If you are a frequent traveler and your work requires you to pay for expenses that are reimbursed later, it makes sense to get a credit card so your everyday cash flow is not affected. But for most young professionals, the temptation proves too much. When I moved to Dubai a few years ago, there were banks calling me every other day promoting their credit cards and offering me credit limits up to 4 times my income. I had just moved to Dubai and had no credit history! No wonder there is research that shows up to 80% of UAE residents are in some sort of debt, and 25% of those have admitted to defaulting on a payment at least once. Credit cards are not as common here in Pakistan, but they are growing exponentially as our younger population matures. Credit card debt can cause problems that can last a long time if not managed properly.
If you have multiple cards that have balances on them, it is worth developing a systematic approach to paying the monthly installments. You should look to pay off one card at a time, while making minimum payments on the others – start with the one with the highest interest rate. Next, deal with the one with the smallest balance. If you are really struggling with even the monthly payments, it is worth seeking help from friends and family or contacting the bank to arrange a manageable payment plan.
Credit cards are not all doom and gloom however, and can be a useful tool to build your credit profile if used responsibly. Building and maintaining a good credit profile, i.e. making all your payments in full and on time will make future financial tasks easier – such as getting a mortgage or an auto loan. On the other hand, credit cards can be an effective budgeting tool as you can keep track of all your expenses. It is much harder to remember where you spent all that cash you withdrew from the ATM last week. Lastly, credit cards offer benefits like discounts and reward points that debit cards do not. I will cover which ones offer the best deals in Pakistan in a later post. In the meantime, click on which benefit suits you best and compare all the options available to you on our website! Remember, you should always look to act responsibly and put yourself in the best position for long term success. Don’t be fooled by the illusion that this piece of plastic creates – and avoid the situation which would allow you to spend more than you can afford. Understand your spending habits and financial strengths and weaknesses and then ask yourself: do I need it?