Ever open a birthday card from your grandparents and a crisp $10 or $20 falls out? Cash in the card is always a good thing. Kelsey Miller, a high school senior in Bloomington, Ind., got one better from her grandparents as she prepared for a trip to Chile this past summer – a credit card. She can use it only for special circumstances, like on her birthday. “If I didn’t need their permission, I would use it more than I should,” says Miller. “I usually only spend the cash I have on me. If I did have free use of the credit card, I would definitely spend more.”
Restricted credit card use makes sense for most teens, many of whom have yet to experience what can be the darker side of personal finance — debt. Debt is when you end up owing a person or a company a sum of money that you have borrowed from them. Debt has a habit of growing faster than one expects if the full amount is not paid back on time according to pre-specified conditions. Credit cards are often to blame for getting people deeply into debt. When you use a credit card, you are borrowing money from the credit card company, and you are expected to pay it back to the company. Most borrowers receive monthly statements from their credit card companies indicating how much money they have spent and thus how much they owe.
But not all debt is bad. Credit cards can help pay for emergency expenses. Before you sign up for credit cards you should do some investigation, says Laura Levine, executive director of Jump$tart, a financial education group. “It seems simple to sign up for a credit card, but that’s not all there is to it,” she says.
The 411 on Credit Cards
The No. 1 thing to know about plastic is that it’s not free money. Eventually, you will have to pay for what you are charging.
When you use a credit card and don’t pay everything you owe each month, the bank will charge you interest on the balance. When it comes to credit cards, the power of what is called compound interest works against you. Each month, the interest your credit card company charges on credit card debt becomes part of the debt principal for the next month. So, you’re paying interest on your interest. The less you pay each month, the more interest gets added and the longer it takes to pay off. If you have a $200 balance and only pay $20 a month, it will take almost a year to pay the whole bill. If your balance gets up to $1,000, it will take 11 years to pay it off. That $1,000 will end up costing $1,732 with interest charges.
It’s hard to get a credit card if you are under 21, but some high school students, like Miller, have them. Bryan Ryherd, a high school senior in Terre Haute, Ind., has had a Visa card for about two years. He uses it for just about everything, including gas and clothes, and pays his own bills. He tries to limit his spending to $100 or $200 a month. “I try to keep track so I don’t overuse it,” he says. “Most of the time I pay it off.”
If you don’t keep track of your bills, it can mean big trouble for years. Late payments, especially over several months, will lower your credit score, a number that predicts how credit-worthy you are. If your score is low, it can make it hard to do a lot of things, including get a cell phone, buy a car, get insurance or rent an apartment. “It’s all about reputation. Companies want to see responsible use of credit,” says Heidi Berardi, vice president of Family Credit Management in Rockford, Ill. “They don’t want to see that you can’t pay your bills on time. Why would they lend you more money?”
Proceed with Caution
A new law requires anyone under 21 who wants a credit card to prove he or she has money to pay the bills or have a parent co-sign on the card. Getting a parent to co-sign on a card can be a good idea for teens who need a credit card for emergencies, but remember that if you don’t pay the bills, your parents will have to. “If you co-sign, you’re both responsible for that debt,” Berardi notes. “Everyone should understand what they’re signing before they make that commitment.”
The same advice goes for the freebies that credit card companies will offer, even once you have received your card. Perks like no interest charges for six months are great, but make sure you don’t spend so much that you can’t pay off your balance when that period is up. Credit card companies may give you cash back based on how much you spend, but it’s usually just a few cents for every dollar – hardly worth racking up big bills that you can’t pay just to earn a few dollars at the end of the year. The bottom line, says Berardi, is not to sign up for every card offer that comes along. “Pick a low-limit card, pay it off and build your credit history,” she says.