Credit card usage is often a sign of increased financial confidence of an individual, but it can also reflect one’s financial management skills. Credit cards provide convenience to users, but there can be a price to be paid if they are not used properly. Every credit card user must understand that usage alone is not enough; one must learn the ways to use it smartly in order to get the best out of it.

Here are a few factors one needs to consider while using a credit card.

Credit limit: One aspect of a credit card is credit availability, which is where card users often end up making a mistake. There is a limit to the credit allowed by a bank on a particular credit card and this is based on the income level as well as other factors such as the user’s past relationship with the bank. For example, the credit limit on a card for one individual may be Rs 60,000 while another person with a similar card may have a higher credit limit at, say, Rs 100,000.

Many people take this limit as the amount they should spend and go about using the card till the limit. This is not the correct approach. For, the credit limit is the figure till which the bank is willing to lend to the individual customer. Just because someone is willing to lend till a particular level, it does not mean the card user should spend that much. The credit limit is the figure up to which the card user can spend. But while using the card, one has to consider the individual’s capacity to repay, and it will depend on the income, savings and the need to use a credit card for such expenses. This distinction is important, else the card user will be making decisions based on a wrong factor. There has to be a distinction between the availability and need to use a credit card to a particular limit.

Determining paying ability: Once the user has understood the distinction between credit limit and actual spend, the next factor one needs to determine is the extent of expenses that will be made on the card.

This is important, because many people first spend and then look for options to pay for it. It makes no sense to splurge on an LCD TV by using a credit card and then look for ways to pay off the amount. Instead, the card user should follow the opposite approach. Which means, she should first determine where the money for a particular expense is going to come from and then go for it by using the card. For example, if one has a budget of Rs 1,500 to buy a gift, it makes sense to use the credit card to pay for the purchase. In this case, the amount has already been set aside and the amount can be paid on the due date.

New expenses or substitution: While using a credit card, one needs to consider substitution of expenses. There could be a situation where an expense has been made simply because one has the option of using a credit card. Before making such expenses, one needs to determine whether it is productive or wasteful.

The other situation is where there is a substitution for such expenses. In this case the expenses, which is made anyway in a normal course, simply shift to the credit card. In such a case, there is no risk of over usage of the card as long as the expenses are planned and budgeted for. Instead, the card will be used as a tool for ease and convenience.

Cost involved: Another angle to consider in the overall analysis is the cost involved in using a credit card. The expenses that can arise immediately include the annual expense on the card, if one has taken an extra card for using at specific places. If it is a normal card that does not have any special facilities, then there may not be any annual fee on it.

The other issue is the interest cost that one has to pay on the expenses incurred on the credit card if it is not paid in time. There has to be a balance between the cost and benefits and that is exactly what every card user should strive for.

(The writer is a CA andCertified Financial Planner. This column will appear every Monday.)