Welcome to Financial First Steps

STEP 2: The Truth on Credit Cards

The sad truth is that many people spend much of their life paying off debt they incur as young adults. College students are a likely target for credit card companies, and while the companies have now been banned from setting up in student unions, there are many other ways they can entice your son or daughter. A lot of young adults don’t understand compound interest, and how a debt grows. As parents, you can help them. Start by explaining the Rule of 72 (PDF), which is useful to teach any kind of compounding. This shows a quick way to estimate the effects of compounding over time. In addition, by visiting our How Investments Grow (PDF), you can show your son or daughter how investments grow over time.
Often we learn about compounding in terms of assets growing, but it is important to teach your young adult that debt compounds in the same way, often with much higher interest rates. One reason why many people have trouble paying down credit cards is that the payments they are making are only going toward interest, rather than toward paying down the incurred debt. This is similar to mortgage payments in the early years of home ownership.
Another important thing about credit cards that many young adults don’t completely understand is credit scores. Good credit scores are important to get the best rate on any kind of loan, and the surest way to ruin a good credit score is with late payments. Explain to your young adult that paying their bills even one day late leaves a blemish on their credit score and that it will cost them on all future purchases until it is repaired.
Visit www.annualcreditreport.com to view your free credit report, and share this information with your young adult so that they understand how credit scores work. The good news is that a bad credit report can also be repaired with a series of on-time payments. It is also important to teach young adults to pay off the credit card debt as soon as they are able, and if they cannot pay it off in full, to pay off as much as they can each month.	Student Loans If your young adult is in college, when they graduate, they will have to pay on student loans that had been deferred, so be sure to remind them to add that to the budget calculations when the time comes.
As you can see from the Rule of 72 (PDF), compounding interest on credit cards will increase the total debt over time. View the 2-page PDF, How Debt Grows (PDF) to better help your son or daughter to understand why it is beneficial to pay off credit cards as soon as you are able. Also remind them to check the credit card’s interest rate, since rates as high as 28% are not unheard of! The Credit Card Worksheet (PDF) will help your student to track their credit card debt, and help determine how to best pay down that debt. It is important to teach your son or daughter about not living beyond his or her means and that credit card debt is detrimental to their financial future. Again, be patient. This can be an overwhelming time, so listening and understanding will go a long way.