Understanding Credit Essential To Financial Success

Photo via Wikimedia Commons

Basile Morin

Photo via Wikimedia Commons

Lauren Cincotta, News Editor

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When shopping, dining at a restaurant, or buying gas, how do you pay? In the past, the only option was to pay with cash.  As society moved towards electronic methods of doing everyday tasks, other methods of payment such as credit and debit cards gained  popularity with consumers. With these new methods of payment there are also more ways to get into financial trouble. As credit card debt increases nationwide, how can young adults avoid falling into debt that they can carry with them for the rest of their lives? The best way to avoid debt is fully understanding how to responsibly spend your money when using debit or credit cards.

So how do these cards work? Debit cards are directly linked to your checking account. When you make a purchase with a debit card, for example a $20.00 payment on gas for your car, that $20.00 is directly removed from your bank account. This is similar to payment with cash-once money is spent, it is gone. This card only allows you to spend what money is in your bank account. If a customer tries to spend more than they have, the card is declined. In some instances, the purchase may go through lowering the account balance to a negative number.  If the account balance reaches a negative number, an overdraft fee may be charged. This can be costly, especially if the card is overdrawn multiple times. However, there are some banks that allow customers to transfer money from their savings account to the card to avoid overdraft fees. Some debit cards do not allow overdraft protection, the purchase is simply declined. Debit cards are very common first cards for teens because they offer an alternative to cash without the danger of accumulating large debts early in life.

Credit cards greatly differ from debit cards in the number of options, perks, dangers and usage. The basic function of a credit card is to place the purchase on credit. A credit card customer must have a line of credit. This means that when someone pays with credit, they are using money that they do not have. The money spent is supposed to be paid back later. If a credit card customer uses their card to pay for $20.00 in gas, the money is not gone taken right away. The $20.00 is paid by the credit card company for the time being. As wonderful as that sounds, the money needs to be repaid. Credit card customers receive bills monthly. At this point it is time to pay the money back, or at least some of it. The cardholder must then pay the company the total amount of money for purchases they made on the card that the company temporarily covered. Ideally this bill would be paid in full as soon as possible.  

However, in many instances the customer cannot pay off all that they owe in one month. What happens then? Well, most credit card companies have a minimum amount that customers must pay on their balance. Recently, credit card bills changed, they now show how long it would take to pay back an amount if you pay the minimum balance each month. The CARD Act created more protections for college students and young adults after years of increased bankruptcy declarations from this age group.  This helps give the consumer a more realistic picture of how much debt they have accumulated. Once the monthly minimum is paid, other payment can wait until a later date. This flexibility comes at a price. If a balance is not paid in full then the remaining amount is carried into the next month. Interest and late fees are then charged. Interest is a percent of the total amount of money that is added onto the balance if it is not completely paid.

Stacking up credit card charges is easy. Unless consumers are mindful of what they charge, they can quickly end up with debt that will continue to grow over the years. Teenagers that use credit cards should learn to use them as responsibly as possible throughout their high school years because bad credit can hurt someone their whole life. Credit is used to buy houses and cars. When someone wants to buy a car or a house, they often take out a loan to pay off the purchase. Before getting a loan, a client’s credit score is checked. A high credit score means that the client is on time with their payments and does not incur any fees. A low credit score is like a red flag-this person has fallen behind in their payments. This would affect the loan the client is about to receive. Depending on their financial situation this might affect the individual’s ability to make the purchase.

Credit cards however, are not all bad. When used responsibly, credit cards allow customers financial flexibility, credit building, and security. By paying off purchases and not charging money that they do not have, a consumer can build a good credit score that can be used in life. Additionally, credit cards are more secure for online purchase because they offer fraud protection. Debit cards do not offer this protection. If a consumer’s credit card is compromised, they can contact the company and measures can be taken to protect their money. The protections differ by company but some of the most common are freezing the card to prevent further unauthorized transactions, not to mention that there are laws in place to protect victims of credit card fraud. By reporting the fraud to the company so they can address it, a consumer cannot be held liable for unauthorized purchases made on their card in the event of a breach.

Also, credit cards may offer perks or bonuses for consumers. These rewards programs differ by card. Dining and traveling rewards are popular with many consumers able to gain points that they use toward rewards on airlines or in restaurants. Some cards also offer cash back meaning that a percent of money charged to the card is given back to the consumer as a reward. A consumer that responsibly uses a credit card can use these perks to their advantage, saving them money in many aspects of their life.

Across the country, the amount of credit card debt is increasing yearly. Irresponsible spending is the leading cause of this increase. The temptation to spend more than can be paid monthly is something many consumers face on a daily basis. Before charging a credit card purchase, it is wise to consider, would you still make that purchase if you were paying with your own money upfront, and is it realistic given that you will have to pay with your own money eventually. Teenagers with their first cards are more likely to spend money and then have trouble paying it back. Confusion over minimum balance and overall payoff is the leading cause of financial mismanagement.

In an anonymous, random survey conducted of 128 WSHS students at varying grade levels 106 students said they had either a basic or clear understanding of the function of credit and debit cards. However- only 26.6% of those students said they used a debit card. Credit card numbers were at 3.9%. There is no national figure for high school students with credit cards because only people 18 or older can have one in their own names. People ages 18-21 can have their own credit cards, but with restrictions. Credit card companies must have proof that the individual can pay back money borrowed as well as other guidelines. Once, an individual can apply for a credit card without these rules that were established in the CARD Act of 2009. However, individuals under 18 can be added as an authorized user to an adult credit cards. This allows them to use the card to make purchases in the account holder’s name, using the account holder’s money. This is a great first step for teens looking gain some financial responsibility without long term effects on their own credit. This does require a certain level of trust between the account holder and any authorized users.

This option might be suitable for young teens, but college students and young adults require more financial independence. However, nationally, credit card debt for college students is at an all time high. Irresponsible spending and assuming student loan debt greatly affect college students after they graduate and are looking to start their lives. Financial Literacy, a understanding of how finances work, is crucial to maintaining a good credit score and staying out of debt as much as possible. For someone looking to increase their financial literacy, there are classes that can help improve understanding. Personal Finance, is offered here at WSHS and at many other schools as an elective. The Massachusetts Financial Literacy Task Force is leading an initiative that would make taking a course that teaches financial literacy a graduation requirement for students. Learning how to manage finances at an early age can set teenagers up for financial success.