When To Purchase With A Credit Card Vis-a-Vis Debit Card And The Benefits Associated With Both

Stuck in between debit card and credit cards

Shailesh, 26, earns Rs 80,000 per month and saves almost half of the salary. He owns an International Gold debit card and two credit cards. When it comes to purchase, Shailesh prefers to swipe credit cards instead of the debit card. One day, his eyes fell on a mobile phone and he took instant liking to it. The phone comes at a steep Rs 43,000 but the shop is offering a 2.5 per cent discount on it if the purchase is made with the same debit card that Shailesh owns. But Shailesh is keen on making the payment with a credit card as he wants to maximise his reward points. He is too confused as how to make the payment, so he evaluates the four options that he has separately. His options are:

• Use the debit card and avail 2.5 per cent discount
• Use a credit card and get the maximum interest-free period
• Use a credit card and make use of the EMI facility
• Use a credit card and transfer the balance to another card

Option 1: Use the debit card and avail 2.5 per cent discount

The International Gold debit card that Shailesh is so unwilling to use for purchase comes with the following benefits:

• Special discounts on certain purchases
• 1 reward point on every Rs 200 spent on the card

Each reward point on this card has a conversion value of 50 paisa (approx.). These reward points could be redeemed for purchase of various articles.

Now, if Shailesh uses his debit card to purchase the mobile phone he will get a 2.5 per cent discount, amounting to Rs 1,075. Plus, the purchase gets him 215 reward points (Rs 43,000/Rs 200 = 215). The conversion value of these reward points is 215 x Rs 0.5 = Rs 107.5. Thus the effective cost of the phone comes to Rs 43,000 – Rs 1,075 – Rs 107.5 = Rs 41,817.5, which means a saving of Rs 1,182.5 for Shailesh.

Option 2: Use a credit card and get the maximum interest-free period

Before checking out this option, let us know what benefits the two credit cards are offering to Shailesh.

Benefits on Card A

• Up to 60 days of interest-free period
• Special discounts on retail spends
• Balance transfer facility
• 2 reward points on every Rs 100 spent on the card
• Conversion of spends above Rs 2,500 into EMIs of duration 6 months, 12 months, 24 months or 36 months

The reward points have an approximate conversion value of Re 1 and they can be redeemed for purchases

Benefits on Card B

• Up to 50 days of interest-free period
• Balance transfer facility
• 5 reward points on every Rs 100 spent on the card

The reward points have an approximate conversion value of Re 1 and they can be redeemed for purchases.

Now, let us turn to Shailesh's second option. It involves use of a credit card to purchase the phone and making payment in full on the due date. Shailesh can choose either card A or card B.

1. If he uses Card A…
   On Card A, Shailesh will get Rs 43,000/Rs 100 x 2 = 860 reward points, that amount to 860 x Re 1 = Rs 860. There are 60 interest-free days available on the card. If Shailesh chooses to keep the money (Rs 43,000) in his savings account, he will earn an annual interest of 3.5 per cent on the same, amounting to Rs 247. Here, the effective cost of the phone comes to Rs 43,000 – Rs 860 – Rs 247 = Rs 41,893, which means a saving of Rs 1,107 for Shailesh.
2. If he uses Card B
   On this card, Shailesh will get Rs 43,000/Rs 100 x 5 = 2150 reward points, equivalent to Rs 2,150 (conversion value of each reward point is approx. Re 1). The interest-free days here are 50 days, thus if Shailesh keeps the amount in a savings account he would earn Rs 206 at an annual interest rate of 3.5 per cent. In this case, the effective cost of the phone is Rs 43,000 – Rs 2,150 – Rs 206 = Rs 40,644, which means a saving of Rs 2,356 for Shailesh.

So, we can say that, in case Shailesh decides to use a credit card, he should use card B as this card offers him a better value proposition.

Option 3: Use a credit card and make use of the EMI facility

EMI facility is available on only card A. If Shailesh uses this facility, he has to pay a processing fee of 0.5 per cent, which comes to Rs 43,000 x 0.5% = Rs 215.

In this case, he chooses the EMI period of 12 months, for the monthly payout (Rs 4,320) will be well within his budget and he also does not want to keep a debt outstanding for a longer time.

His bank charges 3 per cent interest per month (42.58 per cent p.a.) on the facility which makes the funds available to Shailesh for one year. These funds if kept in a savings account yield an annual interest of 3.5 per cent. So, we can say that the net interest cost of the EMI scheme will be 39.08 per cent.

Thus the effective interest payout (using the method of reducing balance) comes to Rs 8,181. The net cost of the phone is hence equivalent to Rs 51,396. (Price+ Processing Fee+ Interest costs).

On this card, Shailesh also gets reward points equivalent to Rs 860. Taking into account, the benefit provided by reward points, the effective cost of the phone becomes Rs 50,536, which means Rs 7,536 more than the actual cost.

Option 4: Use a credit card and transfer the balance to another card

Balance transfer facility is available on both credit cards, so Shailesh needs to see which card offers him better discount in pricing. Since both cards charge 3 per cent processing fee, he has to evaluate the reward point option.

Card B offers a better value in terms of reward points (Rs 2,150) than card A (Rs 860), so it would be wise for Shailesh to use this card for the phone purchase and then transfer the balance to card A. The facility provides an interest-free period of 90 days after which the payment had to be made in full.

The processing fee is equivalent to Rs 1,290 in this case. Taking into account the reward points and the processing fee, the net cost comes to Rs 42,140. In addition, Shailesh will also earn an interest of Rs 371 if he keeps the funds in savings account (interest rate 3.5 per cent p.a.) for 90 days.

So, the effective cost in this case comes to Rs 41,769, which means a saving of Rs 1,231. This option also provides Shailesh 3 months' time to pay the funds.

Since all the four options are evaluated now, we summarise the results in the following table.

*Calculated using the differential between total EMI Payment and the actual cost

** Calculated using the principal amortisation schedule

Summing it up

• Debit card offers Shailesh a significant upfront discount and also some reward points. Though the value of its reward points is less compared with those offered by both credit cards, it is more than made up by the upfront discount.
• Credit card B provides an attractive value on reward points and also allows Shailesh to pay the funds 50 days later. Thus it seems a better option if Shailesh wants to use the second option.
• EMI scheme is quite expensive and can only prove to be useful in case Shailesh does not have sufficient funds to make the full payment.
• Balance transfer scheme is attractive as it reduces the effective price and also allows Shailesh to make the payment after 3 months. But this option can be used when Shailesh does not have money to make immediate payment and is expecting some funds after 3 months.