CHAPTER EIGHT
If you’re in need of cash, one option is to borrow it. But borrowing is a major decision. You don’t want to end up taking on more debt than you can safely pay back.
You might have heard the term “financing.” That means taking out a loan to purchase a big-ticket item, such as a car, house, or furniture. Young people also commonly borrow money to pay for college. And when you pay for purchases with a credit card, you are using the bank’s money and agreeing to pay it back. If you buy a candy bar with a credit card, you are borrowing money to pay for it.
You have several options if you decide to get a loan. You can ask family or friends for a loan. You can borrow from a bank, either through a credit card or a bank loan. It tends to be easier to qualify for a credit card than for a bank loan. Since the Great Recession of 2007–2009, banks have stricter loan standards.
Peer-to-peer lending websites such as lendingclub.com and prosper.com are another option. These sites allow strangers to lend and borrow money from one another.
Banks lend money to make money. When you borrow from a bank, the bank charges you interest. You must pay the interest back along with the amount you originally borrowed, which is called the principal. However, if you borrow money from friends and family, they might not charge you interest.
Whether to borrow from family and friends can be a sensitive issue, so it’s important to devise a clear plan for how to pay it back or you risk straining your personal relationships.
When you borrow money for a house or car, the lender will usually require a down payment up front. It’s calculated based on the total purchase price of the item. A typical down payment is 20 percent of the purchase price, but smaller and larger down payments also may be allowed.
At one time it was very easy to get a credit card. Companies even used to market credit cards on college campuses, offering students free T-shirts and other goodies in exchange for filling out a credit application. The widespread availability of credit got some teens and young adults in trouble. And stories about how credit contributed to the financial problems of the Great Recession have some consumers fearing credit cards.
But credit isn’t all bad. It’s a way to make purchases easily without having to carry a lot of cash. Credit creates a helpful record of your spending and is a good safety net if you need money in a crunch. But the terms and conditions of credit cards, which often are buried in fine print, must be understood so you don’t spend more than you can afford to repay or rack up unexpected interest and fees.
A good rule is to use a credit card for just the purchases that you can afford to pay off within the grace period, which is the amount of time you have to pay your credit card bill before you are charged interest. Interest on credit cards is measured with an annual percentage rate (APR), which means interest expressed over a yearlong period. The grace period usually is about a month, but check with your credit card company to be sure.
Credit card companies are restricted by law from marketing cards the way they used to. If you’re younger than 21, you must prove you have the income to pay your bill or have a co-signer who is older than 21 who agrees to pay if you can’t. Another way to build credit is to have a parent add you as an authorized user to his or her credit card account.
Most banks require a minimum monthly payment on credit card accounts. Minimum payments tend to be small—as little as 2 to 3 percent of your total balance. But don’t be tempted to pay only the minimum. The less you pay on your bill, the more you’ll end up paying in the long run. If, for example, you have $1,000 in debt at an APR of 18 percent and your minimum payment is 2 percent, you’ll pay a total of $1,863—$863 in interest—and take eight years to pay off the bill. If you doubled the minimum, you’d pay the debt in three years and save $600 in interest. If you don’t have the money to pay your credit card bill in full, pay off as much as possible to limit the amount of interest you’re charged.
Credit card companies are now required by law to include a section on the minimum payment on cardholders’ monthly statements. The section should include how long it will take to pay off the bill at the minimum monthly payment, as well as the total amount charged.
In addition to minimums, there are also maximums. Cards have a credit limit, which is the maximum amount you can have on your credit card account at one time. Keep in mind that banks can set credit limits pretty high. Limits are no indication that you should charge that amount of money or could even afford to pay off that much debt.
Interest is just one type of fee banks may charge for credit card use. There are late payment fees, fees for using the card at ATMs, and fees for transferring charges you have on one card to another. Some banks also charge an annual fee for cards. These cards typically come with travel rewards or other benefits. It’s important to calculate whether it makes sense to pay an annual fee for a credit card. In most cases the answer will be no, especially if it’s your first credit card or you carry a balance. Cards that give users rewards tend to have higher interest rates.
The fine print of credit card agreements is riddled with legal terms and hidden fees. But it also can contain perks that people may overlook.
Three key perks of some credit cards:
It’s Friday night and you’re out with friends. You decide to go out for pizza. You are trying to be a savvy spender, so you buy the pizza special—$2 off a large pepperoni. You charge the $15 cost to your credit card. Your friends give you cash for their share, so your true cost was just $5. But you end up spending the $10 on candy and chips at the convenience store.
Let’s say this scenario plays out each Friday. After about a year you find yourself with a $750 credit card bill and only enough money to pay $20 a month. If your credit card charges an interest rate of 18 percent, it will take five years to pay for those large pies, and you’ll pay an extra $361 in interest. It’s a calculation that can give you massive indigestion, especially when you think about how that money could have paid for a new smartphone or other big purchase.
Your credit score is kind of like a grade-point average for your money life. It’s used by banks to decide whether to lend you money and at what interest rate. But landlords and insurance agents also look at it when deciding whether to rent you an apartment or to determine your car insurance costs. If your score is in the basement, you could lose out.
There are several credit scores on the market, but most lenders look at the FICO score, which is named for the score’s creator, the Fair Isaac Corporation. The score ranges vary, but the higher the score, the better. Some credit card issuers provide a free peek at your credit score. If they don’t, you can purchase a score for less than $20 at MyFico.com or estimate your score for free at creditkarma.com.
Your credit score is based on your credit report. This document is filled with your financial history—which accounts you have and how well you’ve managed them. You have the right to receive one free credit report from each of the three major credit bureaus every year through www.annualcreditreport.com. You should take advantage of that free report not only to check for mistakes, but also to check for identity theft or other types of fraud.
Source: http://whatsmyscore.org/facts/
If you’re having trouble qualifying for a credit card because you have no history or a low credit score, a secured credit card is one option.
A secured credit card requires you to deposit money in an account before making purchases. An unsecured credit card doesn’t require any money up front. The bank is placing faith in you to pay back the charges.
For many teens, buying a car is their first major purchase. When you buy your first car, you’ll need all of your financial literacy skills—assessing needs versus wants; researching a big purchase; budgeting for the car payment, gas, insurance, and maintenance; and using savings or getting financing. They are all important when it comes to selecting the right vehicle for the right price.