Financial Lessons: Credit Cards

Happy Labor Day, Everyone!  I hope you've all had a good, cook out and picnic filled day.  Myself, I spent most of the day as I do every day since I got my new job: sleeping.  Yes, the joy of being nocturnal on a day devoted to sun, freedom, family, and of course, the pending return to school for any under the age of eighteen.

And it's to those people I'd like to devote this week's articles.  One of the concepts bemoaned in the financial media (including blogs like this one) is that one of the big holes in the American education system concerns the lack of financial education.  In spite of the fact that everyone needs to know how to manage their money while only a fraction of the student body will make their living applying the lessons from chemistry and English class (to say nothing of gym), there's little to no mention of money management and smart financial moves in high school.

That's where I come in.  This week, we're going to go through some of the basics about personal finance and money management that somehow never come up in your high school career.  If you're a high school student (or even younger; it's never too early to get a handle on personal finances) wondering how to get a jump on your financial education without taking a few lessons at the School of Hard Knocks, you've come to the right place.  But don't worry if you're an older reader; the information is just as valid for you, and perhaps you can even contribute to educating the youngsters in the crowd.  Let's get started!

The Lesson

Alright, class, settle down, it's time for class to begin.  *The sound of chairs scrapping as students return to their seats.*  Today, we're going to be talking about credit cards.  In spite of what you may have gleaned from television commercials, credit cards aren't a source of never ending wealth.  Nor are they the devil in plastic form, as you may have heard from certain financial personalities.

Credits Cards: Neither Friends nor Enemies
Credits Cards: Neither Friends nor Enemies

In reality, credit cards are simply a way to borrow money.  The agreement you make with the credit card company is that when you make a purchase, they will pay the merchant, and in turn, you will pay them back at some point in the future.  Credit card companies will give you a period of time after they calculate how much you spent that month, called a grace period, before the bill is actually due.  If you pay off the credit card bill in full by the grace period, congratulations!  You don't owe any interest on the money you borrowed from the credit card company, and because you had that money to invest during the interim, you can come out financially ahead of anyone who made the same purchases with cash or a debit card.

The problems start to arise if you don't pay off the card in full each month.  After the grace period, you will start to be charged interest on your borrowed money, up to 30% or more annually.  Furthermore, the interest is usually compounded daily, which means that every day during which you have your balance, the amount you owe will increase just a little more.  Don't panic too much, though; even with such high interest rates, having a few hundred dollars on your card that need to wait a month to pay off isn't a huge tragedy.  If a sudden, unexpected expense, a sudden decline in income, or simply a miscalculation causes you to put more on your credit card than you can pay off in a single month, just pay what you can and resolve to save up enough money to pay it off in full in the next month or two.

Credit cards only become really dangerous to your finances if you fall into the trap of believing that, ‘Because I can afford the minimum charge, my debt is under control'.  Unfortunately, most credit cards require minimum charges that only a small fraction of your overall debt (usually only a few percentage points of your total owed).  If you only pay that amount, even a card with a modest interest rate, in the range of 10% or so, will cause your balance to increase each month.  Soon, you can end up owing tens of thousands of dollars, much of it from interest and fees rather than actual spending, and no choice but bankruptcy or other extreme measures in order to balance your account.

How do you dig yourself out of such a situation?  While I hope none of you find yourself owing a large amount to a credit card company, there are a few simple tips to pay off your debt.  First, don't add anymore to your amount owed; if you use your cards at all, you must, MUST pay off the added amount each month (or better yet, declare a moratorium on credit card spending until you get your debt undr control).  Second, pay more than the minimum on your cards; as we just discussed, paying your minimums will at best lead to your account total slowly increasing.  Pay as much extra as possible, preferably on the card with the highest interest rate.  Third, keep repeating this process until all of your credit cards are paid off.  It's really that simple; no elaborate plans needed, as long as you can control your spending and put as much as you can towards your debt.

Alright, so now you know how NOT to use credit cards, let's consider what you should look for in a credit card.  A decent interest rate is always good; although you will hopefully never carry a balance, knowing you won't have to pay an arm and a leg in case you do can be a real comfort.  You might also consider the rewards offered by your card; getting cash, travel miles or other rewards for your normal spending is nice, and if you never pay interest, it's basically free money.  You should also look at the annual fees (if any), and determine whether the rewards will outweigh the costs.  And of course, intangibles like costumer service and easy to use websites can also help you to decide which of two seemingly identical cards is best for you.

That's it for our introduction to credit cards; hopefully, you all know now how to avoid the pitfalls of credit, while still using them properly.  For your homework, check out your credit card statements (or those of your parents, if you don't have a card already) and try to understand all the minutiae of the credit card language used.  If you don't understand the language used, bring in your questions and we can discuss them tomorrow.  *The bell rings*  Have fun in your next class.

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