Credit cards are not just for adults anymore. In fact, one-third of all American teenagers are cardholders. However, because it is so easy to get into financial trouble with that little piece of plastic, it is important to learn how to use it before ever uttering those magic words: “Charge it!” Here are four important things your teen should understand about credit cards.
What Is Credit?
When you pay for something with a credit card, you are borrowing money from the issuer (bank, credit union, or other financial institution), with the promise that you will either repay it all or make the minimum payment requested when the bill comes. If you don’t pay it in full, the remaining sum will “revolve," meaning it will be added to the next month’s bill. Interest will be added to the balance also, and will continue to rack up until the debt is paid.
Example: You charged $500 for school books and materials, but can only pay $25 a month. If the interest rate on your credit card is 10%, it will take you one year and 10 months to repay — plus $49 in interest. However, if the interest rate is 22%, it will take two years and two months to repay that original $500, plus you’ll owe an additional $129 in interest.
How you use credit matters! If you want to finance a car, get a cell phone contract, rent an apartment, obtain a job, qualify for low insurance rates, and (one day) buy a home, you will need to treat credit right — not just now, but over the long term.
How to Get Credit
Getting started can be a challenge. After all, without a credit history to assess, how will a credit issuer be confident you will repay what you borrow? They can’t, which is why one of the best ways to begin is with a secured credit card. This type of credit card is linked to a savings account, and your credit line is equal to the amount of the deposit. Because the credit issuer may claim the funds in the account if you fail to pay, they assume little lending risk and so are more open to lend to a newcomer.
Store and gas cards can be another good option, since they often have less rigorous standards than unsecured credit cards. They may only be used at a specific store or service station though, and the interest rate is often higher than other forms of credit.
Finally, when you have proved your credit worthiness, you are ready for an unsecured credit card.
When shopping for any credit card, look for the following:
- Low annual percentage rate (APR). The lower the APR (the interest you are charged on balances), the less you’ll pay to hold onto debt.
- Long grace period. A grace period is the number of days (typically 15 to 30) you have to pay your bill in full before interest is added. The grace period usually applies only to new purchases, but in some cases (check the application!) it is completely eliminated if you carry over a balance from a prior month.
- Low cash advance fees. Though you may be able to take cash out from your account, it is best avoided. Average service fees are between 2% to 3% of the advance, and interest kicks in immediately.
- No annual fee. If you are new to credit you may have to pay an annual fee, but after a year or so of good use, you can ask for it to be reduced or eliminated.
- Low penalty fees. You will be charged hefty fees if you pay after the due date or go over your credit limit. Though you should manage your account so you do neither, look for low penalty fees anyway. Just in case.
How to Use Credit
Once you have a credit card, use it wisely:
- Stay out of debt. It doesn’t take long for a few purchases to add up to hundreds, even thousands, of dollars. Never charge more than you can afford to repay by the time the bill comes in. To avoid overspending, keep a record of all credit card purchases you make during the month, with a running total of what you’ve spent. When you reach the amount you can afford to pay off, stop using the card until the next month rolls around.
- Pay more than the minimum payment due. If you absolutely can’t pay the entire balance, at least pay more than the requested minimum payment. Because the minimum due is often very low (usually between 2–4% of the balance), you’ll drag the debt out for many, many years if that’s all you pay.
- Pay on time. Miss a payment cycle and your credit history will take a quick and hard hit. And if you fail to pay by the due date you will have to pay that late payment fee – typically $25 to $40.
- Limit the number of cards you have. Only apply for the plastic that you absolutely need. The more open credit lines you have, the more you’ll be tempted to spend beyond your means. Also, too many applications can hurt a credit score
What are Credit Reports and Credit Scores?
There are three major credit-reporting bureaus in the US: TransUnion, Experian, and Equifax. These companies collect credit-related data, compile it into reports, and then provide it to businesses that need to evaluate lending risk and make other business decisions. Your credit and debt information will be on these reports in detail, including when you opened the accounts, if you’ve paid on time, how much you owe, if accounts have gone into collections, your credit limits, and if you have been sued for a debt.
Think being graded ends with school? It doesn’t. The way you treat credit is graded (scored) all your life. A credit score is a mathematical risk assessment based on the information on your credit report. A common scoring model is one developed by Fair, Isaac and Company. It issues a FICO score that ranges from 300 to 850. It is based on (in order of greatest weight) payment history, amounts owed, length of credit history, pursuit of new credit, and types of credit in use. High scores translate into cheaper loans an increased edge for employment and housing opportunities.
A credit card is not just a convenient payment method, but also a way of proving stability and responsibility. Always use credit wisely — your future depends on it!
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