In today's world, it's tempting to apply for new credit cards, especially when brands like Amazon, Shoppers Stop, and others offer attractive co-branded cards with lucrative rewards. However, the question is whether it is wise to keep signing up for new cards just for the perks, or should you stick to using your existing ones even if they offer slightly lower rewards?
The answer is a definite No—you shouldn't keep accumulating credit cards just for incremental benefits. The drawbacks far outweigh the rewards. Managing multiple cards involves various challenges, including activation, timely payments, annual and joining fees, and keeping track of due dates. But the real concern is the financial impact of holding too many cards, which many people overlook.
The Hidden Financial Impact of Multiple Credit Cards
When you get a new credit card, your total available credit line increases. This might seem beneficial, but lenders assess your financial standing using a metric called FOIR (Fixed Obligation to Income Ratio).
Let's break it down with an example:
Scenario 1: Before a New Credit Card
Assume your gross monthly income is INR 1 Lakh, and you have the following liabilities:
- Personal Loan: INR 2 Lakhs (EMI: INR 10,000)
- Auto Loan: INR 5 Lakhs (EMI: INR 15,000)
- Credit Cards: Total credit limit of INR 4 Lakhs, which will mean 5% of the total credit limit will be added to the FOIR
Your FOIR calculation:
(10K + 15K + 4L * 5%)/1L = 45K/1L = 45%
Scenario 2: After Taking Another Attractive Rewards Credit Card
If you apply for a new card with a credit limit of INR 2 Lakhs, your updated FOIR will be:
(10K + 15K + 6L * 5%)/1L = 55K/1L = 55%
At this stage, everything might still seem manageable.
Scenario 3: When You Actually Need a Loan
Imagine you now need a home renovation loan of INR 5 Lakhs, with an EMI of INR 20,000. Your FOIR will shoot up to:
(10K + 15K + 20K + 6L * 5%)/1L = 75K/1L = 75%
This level of indebtedness is considered high, making it difficult for banks to approve your new loan. Essentially, you might face loan rejections for crucial financial needs, all because you maximized credit card perks for luxury spending.
Best Practices for Managing Credit Wisely
- Assess Your Financial Health: Before applying for a new credit card, analyze your existing credit obligations and their impact on your borrowing potential.
- Maintain a Healthy FOIR: Ideally, your FOIR should stay below 50% to ensure you have room for future financial needs.
- Prioritize Emergency Funds: Always maintain a financial cushion for unforeseen expenses rather than relying on credit.
- Choose Wisely: If you need a credit card, opt for one that aligns with your spending habits and offers long-term benefits rather than short-term rewards.
- Live Within Your Means: Avoid unnecessary debt accumulation by spending responsibly.
Conclusion
While credit cards offer convenience and rewards, excessive reliance on them can jeopardize your financial stability. A well-planned credit strategy ensures that you enjoy financial security and access to essential loans when you truly need them. Always evaluate your long-term financial goals before signing up for a new credit card.
At Financial Health, we give you the opportunity to understand where and how much you should invest to maximize your returns. Also, we help you improve your credit profile so that you are better prepared for any of your future needs.
Frequently Asked Questions
What is FOIR and why is it important?
FOIR (Fixed Obligation to Income Ratio) is a metric used by lenders to assess your financial standing. It's important because it determines your loan eligibility and affects your ability to get future credit.
How do multiple credit cards affect my FOIR?
Multiple credit cards increase your total credit limit, which adds to your FOIR calculation. Banks typically consider 5% of your total credit limit or outstanding amount (whichever is higher) as a monthly obligation, even if you don't use the full limit.
What is a healthy FOIR percentage?
Ideally, your FOIR should stay below 50% to ensure you have room for future financial needs and maintain good creditworthiness.