Would you hand an 18-year old $400 dollars and trust that they would spend it responsibly and pay it back within a month? Well that’s exactly what the nation’s economy is forcing teenagers to do. Opening a credit card is a big step towards adulthood and towards managing your finances, but it’s important that young adults know the risks of credit cards.
Credit is defined as the ability to obtain goods or services before payment, based on the trust payment will be made in the future. Future investments such as vehicles, homes, or even loans depend on past abilities to pay back money that has been borrowed. Most 18-year olds aren’t worried about car loans or purchasing homes, yet we are encouraged to apply for a credit card.
The purpose of having a credit card at the fresh age of 18 is to build credit early. Once you start using credit, you will get a credit score. Credit scores range from 300 to 800 and are generated by a few different companies to show your credit worthiness. By charging as little as possible to your credit card and by paying it back on time, your credit score will remain positive without going into debt.
A person's credit score is composed of a few factors: payment history, debt burden, length of history, types of credit, and recent credit searches. However, a caution of credit is that any occurrences that appear on your credit report remain there forever.
Payment history makes up a large portion of your credit score. Credit issuers set dates for when payment is due; failure to pay the balance on time can result in larger amounts being owed as well as an occurrence on your credit report. A common mistake is exceeding the credit limit then failing to pay back the balance. Not only are you expected to pay back immediately the entire balance, but also any interest the card may hold. This can increase your debt burden.
Debt burden is simply the amount of money owed. For example, if you have a credit card with a monthly limit of $500 dollars, and an APR, Annual Percentage Rate, of 25 percent, your debt burden for that card is $7,500 dollars at the end of the year. If you charge more cards to your name, your debt burden increases.
Issuers often evaluate the length of time you’ve used credit. Banks and credit unions take a holistic look at credit history before issuing loans. They prefer not to see multiple credit cards opened in short amounts of time. In addition to the amount of time credit has been established, the type of credit is important. When applying for a car loan, for example, if your only form of credit is at retail stores or in installment loans, it doesn’t demonstrate credit worthiness as much as a reoccurring credit does. The main thing to remember is that the more often you pay back your debts promptly, the more likely you are to receive a lower interest loan in the future.
With all danger that comes with carrying a plastic card, it is easy to feel removed from the responsibility. While it is scary to handle such large amounts of money, there are ways to use credit smartly.
One of the many things to know before getting too deep into the dangerous world of credit is to know where to get it from. Credit cards can be opened at a bank, credit union, or directly from a credit card company. Credit unions are a little different from banks, the two are pretty much hot and cold.
Credit unions are smaller, not-for-profit institutions, where customers are usually called members. Since credit unions are non-profit, they can offer higher interest rates for savings accounts and certificate of deposits, and lower interest rates on loans and credit cards. The relationship between a member and credit union management is often more personal. By being a member, you become a part owner and are given a say in the credit union’s decisions.
Because credit unions have lower interest rates on credit cards, some people lean towards their local union in an effort to save money and hassle. College students tend to have access to credit unions. It is a good way to start managing your finances with the help of financial experts.
In terms of adulthood and finances, a good way to manage your finances is to set a monthly budget. Figure out what it is that you need to buy, and set money aside so that the credit card bill can be paid as soon as possible. While considering that credit can feel like fast money, you should charge as little as possible to your credit card. This makes it easier to pay back the entire balance each month and thus avoid interest charges.
Having a credit card may seem stressful or scary, considering you are spending money you don’t have. It is, however, preparing you for the real world and teaching financial responsibility. If you proceed with caution, you should be fine.
[Sources: 360 Degrees of Financial Literacy; Creditcards.com; Value Penguin; Credit.com; Bank of America]