FD-backed credit cards can help you build a credit score
If you’re a Gen Z investor and spender, you might not have good credit simply because you might not have used a line of credit until now. A bad credit score or low income makes it difficult to get a credit card or the credit limit you may be hoping for.
One of the ways to circumvent this problem is to opt for credit cards backed by a fixed deposit (FD). The FD here acts as a guarantee, on the basis of which banks agree to issue a credit card.
But before entering, know what these cards are and what are the risks associated with them. Once you master that, make the most of FD secured credit cards.
What are FD Secured Credit Cards?
These are special types of credit cards that come with certain predefined warranty terms and other conditions. To get the credit card, you will need to open an FD with the issuing bank. The credit limit of FD-backed credit cards is usually around 80-90% of the FD amount.
However, you will continue to earn interest on the FD at the specified interest rate and term. The FD will continue to renew automatically until you return the credit card issued against it.
Banks generally do not check income security or credit rating when issuing these credit cards, as they are fully secured against FD.
“People with no credit score (due to no credit history) or 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 guarantees that it continues to earn interest, it acts as a safety hedge for the banks. On the other hand, the risk of losing the FD acts as a reminder and forces the customer to manage their overspending,” said Amit Das, co-founder and CEO of Think360.ai, a data science-focused company and artificial intelligence.
Know the risks
Credit cards can make transactions easier, but they also come with the risk of falling into a debt trap if you’re not smart enough. This is because it is an expensive form of debt and non-payment can land you in trouble. Interest rates on credit cards can reach 20% or even more, depending on the issuing bank.
“Credit cards and personal loans are usually the first line of credit that banks offer to eligible customers. Taking advantage of and using unsecured credit is easy. However, timely repayment is essential. If you repay your dues on time and in full, your credit score begins to grow. If you are late with payments, the score drops,” says Adhil Shetty, CEO of BankBazaar.com.
Remember that while you are using the credit card you will not be able to use the FD as it will be under lien. Also, if you are irresponsible with how you spend, you will be putting your own deposit at risk. In the event of a credit default, the FD will be terminated, and the bank will recover the dues and return the balance to you, if applicable.
Get the Most Out of FD Secured Credit Cards
1. Build a credit score
Credit cards are a good, easy way to establish a good credit score, which is essential when applying for a loan. “FD-backed credit cards help build a credit history, as evidenced by disciplined use. A decent credit rating will allow access to loans and other forms of credit, also on favorable terms,” says Raj Khosla, Founder and Managing Director of MyMoneyMatra, a loan aggregator.
Unless you have a good credit history, lenders may be reluctant to give you money, which can be a problem in the future when you apply for an education loan or a home loan. “Today, loan rates are tied to your credit score. If your credit behavior has been good and your payments are on time, you can take out more loans at lower interest rates. But if your score is low, your loan rates will be higher. In extreme cases, you might not get the loan at all,” says Shetty.
2. Use it for the unexpected
Many students and young professionals may not have cash in their bank account for emergencies. Credit cards can be useful in such situations. But again, experts advise to ensure that repayments are made on time.
An FD-backed credit card can only be used for emergencies while ensuring that your FD continues to pay you interest.
3. Use it to break down big purchases
Many FD-backed credit cards have a relaxed repayment period ranging from 30 days to 50 days. Use this option to spread large purchases by spreading the amount over two months. For example, if you need to buy yourself a laptop worth Rs 30,000, you can repay half of the amount in the first 20 days falling in a month and pay the rest in the following month within the repayment period.
But remember to plan well so as not to miss the repayment deadline.
4. Use reward points
This is one of the main advantages of a credit card over a debit card. You can earn reward points for your purchases by using a credit card which can be redeemed later for other purchases or as cash in some cases. You can use the credit card to fund your daily offline or online purchases and get rewarded for it. However, be extremely careful and don’t overspend.