Credit Cards Vs. Digital Loans: Which One Should I Use When I’m Cash-Strapped

Everyone finds themselves cash-strapped once in a while. And this can happen for multiple reasons, including from an unexpected expense that disrupts your budget to a delayed salary that leaves you broke. 

If this happens unexpectedly and you have bills to pay or need to do some household shopping, you might have to turn to short-term emergency debts.

Short-term emergency debts are loans designed to provide quick funds to a cash-strapped person. They typically have a short repayment term of fewer than 24 months if secured and less than three months if unsecured (e.g., digital loans, credit cards, and payday loans). 

Unsecured loans are preferred for multiple reasons. They don’t require collateral or guarantors, have fast approval, give you the flexibility to use them for any purpose, and are accessible almost instantly. But with so many unsecured emergency loans, which one should you consider  when cash-strapped? 

This article will compare two types of such loans, digital loans and credit cards, by discussing their pros and cons, their use cases, and which one you should consider depending on your needs.

Read Also: Absa's Credit Card Reviews: What Is the Best Option for Me?

Credit Cards and How They Work

A credit card is an ATM-card-like product offered by financial institutions such as banks that lets cardholders buy things and pay bills using a revolving line of credit. 

A revolving line of credit is a loan that remains available month over month even if you repay the entire amount. Think of it as money you have access to whenever you need it. If you don’t need it, you do not pay anything to keep access to this credit active unless the card has an annual fee or an initial registration fee. 

If you have a credit limit of, for example, Ksh50,000 and you borrow Ksh10,000 on March 5, you can still borrow another Ksh10,000 on March 20, and so on as long as you do not exceed the Ksh50,000 limit. 

You will only pay back what you have borrowed from your credit line within a one-month period. This is called the billing cycle. That is, the card issuer collates all the purchases you make during a one-month period and sends you a bill. 

One of the most advantageous things about credit cards is that the bill may actually not be due on say the 31st of March, for example, for this one-month period if your credit card offers you an interest-free period of more than 30 days.

With all Absa Credit Cards, for example, you get at least 50 interest-free days. This means, all that money you spent in March (Ksh20,000 from our example above), is due on April 19, which is when the 50-day interest-free period lapses. 

Read Also: What is a Credit Card’s interest-free period? and How Does it Work?

If you do not have any need for a cash injection in any given month, then you have nothing to repay and if for example you get a credit card with zero annual fees for life such as the Absa Classic Credit Card, then it costs you nothing at all to keep a credit card - since you have not borrowed - or if you paid before the lapse of the interest-free period.

If you do not pay back what you have spent within the interest-free period, then the balance that you carry over will now start attracting interest. Most people make sure they have set a standing order to automatically pay their balance before the interest-free period ends.

If you do not have the money to pay back the full amount you spent in the month, credit cards have a minimum repayment amount that you need to pay in order to keep your account in good standing. For Absa Credit Cards, for example, this is set at as low as just 5% of the balance.

So, for example, if you spend Ksh20,000 in the month of March 2023 and it’s April 19, and you do not have the full amount, all you have to do to keep your account in good standing is to pay 5% of the balance - Ksh1,000 and you can roll over the Ksh19,000 balance to the next 30-day period. This Ksh19,000 is what will be charged interest i.e., the balance carried beyond the interest-free period.  

Note that it is not advisable to only pay the minimum amount if you are able to pay more or in full. This is because there may be temptation to keep paying this small amount for several months which could mean paying high interest when you eventually want to clear the balance.

And why not pay back all you owe within the interest-free period? It’s a revolving credit line. You pay back what you have spent and can immediately borrow again and still not be charged interest as long as you keep paying back within the interest-free window. 

On how much credit card limit you can qualify for; this majorly depends on your income level and also on the type of credit card you are going for. You can, nevertheless, grow the limit as you build your credit history and increase your income. 

For instance, with Absa Bank Kenya, there is a card for someone earning from Ksh20,000 net monthly income which has zero annual fees - the Absa Classic Credit Card - and another  for those earning in the upwards of Ksh200,000 net monthly that comes with numerous rewards from cashback, purchase protection, extended warranties, medical and legal assistance when travelling and more - the Absa Platinum Credit Card. 

Read Also: Absa's Credit Card Reviews: What Is the Best Option for Me?

You can choose from six Absa Credit Cards that offer limits of up to 2.8x your net monthly income. For example, if you earn Ksh70,000 net monthly and choose the Absa Gold Credit Card, you qualify for a limit of up to Ksh175,000. That is 2.5x your net salary. 

How to Pick the Best Credit Card 

Choosing the right credit card can significantly impact your financial well-being. With so many options available, knowing what to look for when picking a credit card is essential. 

While many cards come packed with rewards and cashbacks, the biggest deciding factor for you has to be your own unique needs. 

Why do you need a credit card?

Is it because you run short sometimes and would like some “free money” to meet some obligations before payday?

Is it that you travel often or shop often and you can benefit from all the rewards available by cards tailored for this kind of user? 

Or are you looking for convenience given your busy lifestyle and need all the convenience perks some credit cards offer?

With that in mind, what should you consider?

1. Card Fees: Credit cards come with various charges depending on the provider and the type of card you want. Some fees include joining, annual, late repayment, over the limit, supplementary cards, and card replacement fees. You should compare different providers to see which offers the best deal according to your needs.
2. Repayment Terms: These terms vary from bank to bank. They encompass three things: the monthly interest rate, the interest-free period, and the minimum repayment amount. 
3. Documents Required: This will define if you qualify for a credit card from a bank or not. For instance, one bank might require a six-month bank statement, while another may ask for only three. One bank might ask for your three latest payslips, while another will settle for only the latest one. Some banks do not require one to have a current account with them to qualify for a credit card while others may have this requirement. 
4. Card Features: This is defined by the minimum net income you need to qualify for a credit card and the card limit you receive when you sign up. They vary from bank to bank.
5. Benefits and rewards: Credit cards offer a variety of perks when you use them. These can be discounts when you shop at a selected store or business or buy a travel ticket and cashback rewards when you purchase anything using the card. For instance, Absa offers up to 3% cash back on every Ksh100 you spend on the Absa Signature Credit Card.

Also Read: ABCs of Credit Cards: What to Know About Credit Cards in Kenya

What are Credit Cards Used For? 

Credit cards can be indispensable financial tools with many benefits when you know how to use them to your advantage. Understanding the various uses of credit cards is vital for making informed financial decisions and can help you avoid costly mistakes.

The primary use of a credit card is to make purchases and pay bills. But unlike a debit or prepaid card, you don’t have to load money into your credit card to use it. The bank will give you the money to spend upfront (i.e., a credit limit) with a commitment by you to repay at the end of the billing period. 

Whenever you have an emergency or are cash-strapped, you can use your credit card to make a purchase or pay a pressing bill and pay back later.

Other uses of credit cards include: 

1. To build creditworthiness - Credit cards in Kenya are mostly offered by banks, which are formal lenders who provide other types of loans such as business loans, mortgages, and auto loans. Using a credit card properly can help you build a good credit history that can increase your limit and make you attractive to lenders when you need bigger loans.
2. To Budget and Track Spending - You can limit your spending on your credit card. For instance, if your monthly household expenses are Ksh25,000 - you can ask the bank to cap your credit card to that if your limit allows. This will ensure you don't spend more than you have to. Additionally, the card provider will send you a monthly statement that shows where and how you spend your money. This makes it easier to know where your money is going. Many credit card users say they charge all their expenses to the card and pay it all at the end of the time - saying this helps them stay accountable. 
3. To Earn Rewards: You can utilise your credit card to get the best rewards that match your needs. For instance, if you travel frequently, you can get the Absa Platinum Credit Card that offers discounted rates at over 1,300 Airport VIP lounges worldwide, VISA global merchant offers, including shopping and hotel stays, and free medical and legal assistance when travelling.
4. To Access Instant Short-term Loans: Credit card providers offer a type of loan called a Cash Advance loan.  You can borrow against your credit card limit and available balance and withdraw that money in cash from an ATM or send money to your mobile/checking account. However, you should know that cash advance loans typically don’t have a grace period and attract interest immediately - i.e. you lose the advantage of the interest-free period since you have opted to withdraw actual physical cash. Of course, there are many incidents when you would be forced to have physical cash as opposed to swiping your card to pay. 

Advantages and Disadvantages of Credit Cards

Credit cards are a widely accepted mode of payment in Kenya and can be used to pay for goods and services at major retailers, as well as bills at hotels and for some household expenses. However, their adoption has been slow, primarily due to lack of awareness about the benefits they offer. 

Should you use credit cards? 

To help you decide, let’s weigh the pros against the cons. 

Pros of Credit Cards 

1. Grace period - Credit cards offer an interest-free period that literally could mean you are getting “free money” to use and then return when your paycheque checks in. You will incur no interest if you fully pay off what you owe within the allocated grace period.
2. Low-interest rates - Credit cards attract a relatively lower interest rate, especially when compared to digital loans.
3. Perks - Credit cards come with various benefits and rewards to ensure you get the best deals. For example, Absa offers perks including insurance such as travel cover benefits, Card skimming (Covers unauthorised charges on lost or stolen cards), and Home contents (this covers the home contents of the card holders up to the amount specified).
4. Credit Shield Protection - This is an Absa Bank-specific offer that allows you to waive the outstanding balance on your credit card in case of loss of life and permanent disability at 0.08% of your credit limit. If your credit limit is Ksh100,000, you will only pay Ksh80 monthly.
5. Convenience - You can pay with your card internationally at any VISA-branded point-of-sale machine and shop at an international website. 
6. Easy to apply and low requirement - Applying for a credit card can take a few minutes if you meet the minimum requirements. You are only required to produce the latest payslip to confirm you are employed and meet the minimum salary required. For instance, for the Absa Classic Credit Card, the minimum net salary is Ksh20,000 for existing Absa customers.

Cons of Credit Cards 

1. Potential Debt trap - A credit card gives you access to a high amount of cash instantly whenever you need it. If not properly utilised, it can lead to overspending and a debt burden if you don’t repay your loan in time.
2. Potential to hurt your creditworthiness - Lenders might consider you irresponsible if they notice you have an overdependence on credit cards. Therefore, it is generally advisable not to always use all your limit and ensure you pay your balance on time. Prudent use of credit cards on the other hand will have positive effects on your credit score. 
3. High interest compared to traditional personal loans - While credit card interests are lower than digital loans, they’re higher than the interest charged in regular bank and Sacco loans. However, some lenders like Absa Bank will allow you to convert your credit card balances to personal loans with lower interest.
4. Fees - As seen above, credit cards come with some fees that might add up and drive up the cost of your credit. Ensure you factor them in when applying for a card. 

Digital Loans and How They Work

Digital loans are a type of unsecured personal loans offered by banks, digital lending apps, and some telecommunication companies. From December 2022, these are collectively known as Digital Credit Providers (DCPs) and are now regulated and supervised by the Central Bank of Kenya (CBK). 

These loans are distinct in one significant way; the application process doesn't involve any paperwork as the whole process from application, approval, disbursement, and repayment is done via a phone.

Digital loans can be accessed through an app, website or USSD. 

The digital lending industry took Kenya by storm a few years ago, and until recently, they were associated with predatory lending practices. But the Central Bank of Kenya (Digital Credit Providers) Regulations 2022, that have brought all DCPs under the supervision of the CBK, are expected to see digital lenders adopt new practices that are more consumer-centric. 

You must first sign up for the product to get started with digital loans. Since this type of loan wants to make credit easily accessible, the application process is typically hassle-free. You must typically complete a simple Know Your Customer (KYC) form to get started.

After signing up, the lender will assess your creditworthiness internally and if approved, give you a credit limit. The starting limit is usually the lowest the lender could offer if you don't have a credit history with them. 

Lenders sometimes ask to access and analyse your smartphone data to make a lending decision. They will analyse some data points, such as your M-PESA statement on your SMS logs to create a personalised loan offer for you. 

To get you approved for higher limits, a lender can conduct a credit report search and decide your limit based on your credit history. You will likely not qualify for a loan if you have been negatively listed on a CRB - i.e. you have defaulted on a past loan and are yet to repay it. 

Unlike credit cards, digital lenders don't offer a grace period or minimum repayment terms. You will need to clear the entire amount by the due date or fall into default. Interest, which is typically charged daily, is calculated on any outstanding balance. 

How to Pick the Best Digital Lender

The digital lender you pick will depend on your needs and financial situation - you want to choose the lender that best fits your circumstances. While lending apps and telcos previously dominated the digital lending industry, commercial banks have joined. However, they have stricter requirements than traditional digital lenders.

With that in mind, what should you look for when picking a digital lender?

1. The Total Loan Fees: The cost of credit will vary from lender to lender. The highest fees you will pay will usually be the loan interest. Other costs may include processing fees, late fees, excise duty, withdrawal fees, and rollover fees. For most digital lenders, all these fees are combined and charged as one - that is with exception of fees that are related to defaulting or late repayment. You also want to make sure that you know if the loan “facility fee” as some call it, is charged per loan or daily since this will make a huge difference on the total cost. 
2. Disbursement Method: This will be dictated by the type of lending institution. Some digital lenders will send the money directly to your mobile money account, such as M-PESA; others will send it to their app wallet, where you will have to withdraw (charges apply), and others will send it to your bank account. 
3. Repayment Plan: This will depend on the amount and the lender's terms. Some allow you to pay off the loan as a lump sum bullet payment, others offer monthly repayment, while banks can offer auto-deductions. Additionally, some lenders allow early repayment - i.e. a discount if you repay early - while others don't. 
4. Requirements: The standard requirement for most lenders is that your CRB report must be in good standing. Others (most actually) will require that you have an active M-PESA account. This will vary from lender to lender. You want to make sure the digital loan that you choose allows you the convenience of accessing and spending the cash without requiring you to take more action or sign-up for new services etc. 

Timiza Review: Highest Limit, Lowest Interest Among Digital Loans

Why People Choose Digital Loans

Digital loans offer a quick and easy way to access credit, even for anyone without a bank account. This makes them suitable for two main use cases:

1. To Build Credit History With a Specific Lender: Digital loans' credit limits typically start at low amounts of about just Ksh500. The more you borrow and repay in time; the higher your limit will likely grow. However, when you move from one lender to another, you typically have to start afresh. They are suitable for building a credit history with a specific lender especially for those who have faced difficulties accessing credit from traditional lenders. This way you can have access to credit whenever you need it and start building credibility with traditional lenders when you need bigger loans. 

2. To Have Flexibility On How You Spend The Loan Amount: Digital lenders don't dictate how you will use the loan. You can use it to shop, pay bills, or withdraw without the terms of your loan changing. This lack of restrictions can come in handy during a financial emergency. 

Advantages and Disadvantages of Digital Loans

The digital lending industry has grown significantly and developed over the last two years. On December 7, 2021, the Central Bank of Kenya (Amendment) Act 2021 was signed into law ushering a new era for digital loans. 

Today, lenders must have a CBK licence (or at least have a licence application in review); they must respect borrowers' privacy and data, practise ethical debt collection methods, and ask for customers' consent before sharing their information with CRB. But despite all that, digital lenders still have their fair share of drawbacks.

Pros of Digital Loans

1. Easy online application process as you don't need to visit a bank
2. Fast approval process that's instant or can take less than 24 hours
3. No restrictions on how you spend the money 
4. No minimum income required 
5. Some lenders offer platform-specific perks like repayment date extensions 
6. It’s possible to be approved with no CRB checks or even if you have a negative report on your credit. 

Cons of Digital Loans

1. High-interest rates - Most digital loans have a high annual percentage rate (APR) of over 100%. This is significantly higher when compared to credit cards and traditional personal loans. You must always take time to compare the available options and choose one with the lowest interest rate possible. For example, Timiza, stands out as one of the digital loans in Kenya with the highest limits (Ksh150,000) and lowest total cost (7.25% per month for a 30-day loan).
   
2. High additional and hidden fees - as it stands, over 369 applications for a DCP licence are still pending with the CBK. All these applicants are deemed to be operating legally  until the day a decision on their licence application will be made. As such, it is possible to find digital lenders that are still not forthcoming about the full cost of their loans which could destabilise you once it is time to repay. If you default or delay repayment, your loan costs could increase significantly depending on the digital lender.
   
3. Very low credit limit - New customers receive low limits that might not be enough to address their pressing financial emergencies.
   
4. Requires App permissions - Lenders often ask to access your contact list and SMS logs to determine your credit limit. 
5. Potential to Hurt Your Credit History - Digital loans have a short repayment window; if you default, a lender can report you to a CRB. This came into effect following the gazettement of the DCP regulations referenced earlier in this article. This means, while previously digital lenders were barred from listing you negatively on the CRB, once each lender gets their licence granted by the CBK, they can report you for defaults of amounts higher than Ksh1,000. Now, due to their short-term nature and comparatively much higher lending rates, if you are not prudent with your borrowing, you could find yourself with a negative CRB listing that other lenders will also consider when determining your eligibility for more consequential credit. You want to guard against that.

What to Consider When Choosing Between Digital Loans and Credit Cards 

1. Application Process: The application process is fairly easy on both. However, Digital loans have easier and faster application processes with lower requirements than credit cards. If this is your only concern, you are looking for a one-off cash injection instantly to sort a very specific bill and cost is not an issue to you, then a digital loan may make sense to you. But often, you have to consider more than one factor when making a decision that involves money.
   
2. Total Fees: Both credit cards and digital loans are considered high-cost credit and must be used prudently. However, there is a big difference in how the costs apply. For a digital loan, you are charged a relatively high fee to access the loan and the fees can pile up if you default. For a credit card, you get an interest-free period typically longer than the average duration of a digital loan after which interest starts to accrue. The interest charged by credit cards, while high compared to regular personal loans, is markedly lower than digital loan rates. Many credit cards, however, have annual fees and sign-up fees (one-off) that you should also consider depending on your financial situation and reasons for looking for credit.
   
3. Credit Limit: Credit cards typically have a higher credit limit than digital loans. This is because they decide the limit based on your income, while digital lenders depend on your SMS logs. Other factors internally decided include through the use of AI technology. Both allow you to grow your limit, but with credit cards, the limit increase process is typically more straightforward and faster. Some digital loans, nevertheless, such as Timiza allow a fairly fast increase in your credit limit.
   One of our team members tested out the Timiza app a few months ago and was able to borrow Ksh1,700 on the first loan. After repaying this loan, they now are able to access a loan limit of Ksh46,000!
   
4. Interest Rates: Credit cards have significantly lower interest than digital lenders. Additionally, credit cards only charge you interest after the lapse of the interest-free period on the balance outstanding. With digital loans, the interest is paid on the entire loan amount, there is no interest-free period and note that some digital lenders charge a daily interest fee which can add up to quite a high cost as the tenure increases and even more if you default or are late to repay.
   
5. Repayment Schedule: Credit card providers allow you to borrow and repay at your convenience if you make the minimum repayment. Most digital lenders have predetermined repayment schedules and early repayment has no perks, save for improving your chances of increasing your limit.
   
6. Repayment Options: Credit cards allow users to pay a small minimum amount or make full payments, while digital loans usually require full repayment in one instalment by the due date.
   
7. Perks and Rewards: Credit cards have various rewards, including cashbacks and discounts at selected stores. Additionally, they come with consumer protection insurance that lowers the risk of losing money to fraud. Credit cards suit you if rewards are important to you, as digital loans have none.
   
8. Purpose of Financing: Digital loans have no restrictions, and the lending terms remain the same however you spend the money. Credit cards can only be used for purchases and paying bills. When you withdraw cash from an ATM using your credit card, it becomes a different type of loan - cash advance - which has a higher iterest rate and starts accruing immediately. 

9. Automation: Credit card issuers give you the option to link your credit card to your debit card/current account and activate standing orders to reduce the chance of default or late payment. For instance, Absa offers Autopay, which allows your monthly payment to be debited automatically from your card. This method saves time and eliminates the need to remember. This is not available with digital loans. 

WRAPPING UP

While both credit cards and digital loans can come in handy when you are cash-strapped, they are not always the best option, especially when considering the associated fees. To reduce debt dependency, consider building a solid emergency fund on which you can always fall back on. 

Over-reliance on credit cards and digital loans can lead to debt problems and financial instability. Before taking any loan, always consider your budget and repayment capabilities to avoid financial hardship. By managing your finances responsibly, you can improve your financial health and reduce the risk of financial difficulties in the future.