Improving Financial Literacy: Be Smart About Credit
Wednesday, February 25 2015 12:00am
Credit cards are useful if used wisely, so be smart about it!
By Harry W Greenfield
Glidden Visiting Professor
Partner Buckley King
YOUR WALLET — I read a posting on the web entitled the “5 Financial Mistakes Millennials are Making.” These mistakes are (1) avoiding preparing a budget; (2) misuse of credit cards; (3) not buying a home; (4) saving too little for retirement, and (5) not having life insurance. Two of these items, budgeting and saving, we covered in earlier articles. Today, I will cover the misuse of credit cards. In future articles I will cover the other items.
Before reviewing misuse of credit card it is important to define “credit." Credit is when one party provides resources (a loan) to another party. The amount you pay that person to provide you credit is called “interest." Interest is calculated as a percentage of the amount you owe. When you repay the loan, you have to pay the original amount borrowed (the “principal”) plus the interest. Most interest is calculated on an annual basis. If a person has $1,000 of debt and her credit card charges 12% interest, she would pay $10 in interest on her monthly statement. ($1,000 * 0.12/ divided by 12 months in a year)
A credit card company (a bank or other entity) agrees to give you credit up to a certain dollar amount (your “credit limit.”) You can use that credit to buy anything from a seller who accepts that credit card. The problem with credit cards is how easy they are to use. And, as a result, you can easily charge more than you are able to pay back in a timely manner. Two things to think about when you use credit of any type, but especially credit cards, are (1) how are you going to pay the loan back and (2) is this something you need or merely something you want?
Misuse of a credit card can be detrimental in many ways. It can cause a poor credit rating which will cause you problems when you apply for other credit, insurance, and even for a job. It can require you to continue to pay for an item long after its usefulness. It can cause you to not be able to afford things that you enjoy.
When you have a credit card make sure you know the following:
The costs of using a credit card — annual fees, finance charges (interest), over-the-limit fees, cash advance fees, and more.
When is your payment due?
What interest rate are you paying?
What is your minimum payment?
How long will it take you to pay off your credit card charges?
Did you make the charges that appear on your statement?
Why is it importatn to check your statements?
With the increase in identity theft, review your monthly statement as soon as you receive it to make sure you made all of the charges. Contact the company to question any charges that do not look correct. If you challenge a charge, it is easy to go on line, highlight the charge and challenge it. The credit card company will do a review to verify that the charge is yours.
Why is it important to understand interest rates?
Here is an example: Last month, John owed a balance of $1,863.93 on his credit card. If John made minimum payments, it would take 17 years to pay off his balance. He would pay $1,460 in interest. This assumes that he doesn’t make any additional charges on his credit card during the next 17 years.
How can you pay off a charge and avoid accumulating interest?
When you start your career, you may need to buy upgrade your wardrobe. You could buy a suit and pay 1/3 on the suit when you buy it and charge the rest. Purchase it at the beginning of your credit card cycle, i.e., a day or two after my credit card would be billed. When you receive the statement about three weeks later, you pay another 1/3. Finally, when the bill is due, you pay the last 1/3. That way you use the banks money for up to six weeks, you get three installments to pay for your new suit, and you do not pay any interest.
Credit cards can be very beneficial if used wisely. It can be helpful if you have an emergency or a large dollar purchase. Be smart about credit. Avoid getting into trouble. Pay cash when you can.