The college search is a big step for a teen. By the age of 17, not only are acceptance letters flooding your mailbox, but credit card applications are also sneaking their way in with the good news. In fact some of the applications come with pre-approved cards, embossed with your first and last name. It’s easy to feel important and rich, but it’s also dangerous.
Under the new federal law that takes effect in February, credit card companies can’t issue cards directly to anyone under 21. Instead, their parents or other adults must co-sign for the card, or teens must prove that they have sufficient income to pay off their debt.
College students are using credit cards more than ever. A study last year from Sallie Mae, the nation’s leading educational savings company, found that 84 percent of undergraduates have at least one credit card, up from 76 percent in 2004. The average college student has more than four cards.
And 92 percent of undergraduate credit cardholders charged textbooks, school supplies, or other direct education expenses, up from 85 percent in the previous study. Students who used credit cards to pay for direct education expenses estimated charging $2,200, more than double 2004’s average of $942.
Only 17 percent said they regularly paid off all their cards each month, and another one percent had parents or other family members paying the bill. The remaining 82 percent carried balances and thus incurred finance charges each month.
“People right out of high school are solicited to get credit cards,” said Tara McCarthy, CEO of Financial Rehabilitation Incorporated, a non-profit organization in Minneapolis dedicated to helping consumers gain control of their finances. “People think it’s a necessity…. because credit within itself is so layered within our society.”
While credit companies are targeting them, teens may not know a lot about credit cards.
Mike Jones, 17, of Minneapolis, admitted that his knowledge on credit cards is very limited.
“I don’t know anything really,” Jones said. “I know they’re good for college, cause my brother’s looking into one, and he’ll be going to college this year. I think they help in some ways for paying college expense, but right now I’m not looking [for a card].”
In the Sallie Mae study, 84 percent of undergraduates indicated they needed more education on financial management topics. Some 64 percent would have liked to receive information in high school.
Even though teens may not know much about credit cards, they do know that it could land them in a bunch of trouble.
“It’s pretty much having money that you really don’t have,” said Corinna Rosillo, 17, of St. Paul, Minnesota. “It’s fake money …. People completely overuse it. That’s why there’s so much credit card debt, because people think they have the money and they really don’t. It’s like an illusion.”
More than 13 million adults carry credit card debt of $10,000 or more according to a Financial Literacy Survey released by the National Foundation for Credit Counseling. Last March, consumer debt reached a reported $2.55 trillion, according to the Federal Reserve.
“There’s not the realization that credit cards are actually debt,” McCarthy said. “Credit cards are like virtual money, and people become disconnected from managing their income and their cash flow, or they might find themselves in a situation where they lost their job … then their credit card debt ends up racking up because they’re using it to live.”
A lot of factors contribute to the downward spiral of credit card debt. McCarthy said that when people hit their cash- flow capacity, meaning their expenses exceed their income, they tend to use their credit card to gain the capacity. Once the consumer starts to spend more then they have, credit card debt is waiting for them around the corner. Once it builds up it can take years to pay off.
For example, I have a Capital One credit card with a $1,000 credit limit. If I were to spend the whole $1,000 and pay a minimum balance of $25 a month with an 18 percent interest rate, I would end up paying $538.62 in interest. So I’d end up paying $1,538.62 over five years to pay off the original $1,000.
Missing even one payment can make it very hard to keep up with paying off their credit cards.
McCarthy said that when consumers start to miss out on paying off their credit card bills in full, they get charged many fees that they have never had before. Some of these fees include late fees, over-the-limit fees, cash advances, currency conversion, multiple interest rates, phone bill pay, balance transfer fees, and credit limit increase fees. These unexpected fees can make it easy for a person to default on a credit card. The new law will restrict some of these fees.
“It’s a bizarre world of debt collection,” McCarthy said. “You would think if somebody was struggling that they wouldn’t charge them so much in fees and cost.”
With lengthy credit card contracts, such as the American Express 12-page contract, consumers may not have the time or knowledge to actually read and understand all the small print. Consumers may not know about the fees that credit card companies charge for a late payment.
Chris Farrell, Marketplace economics editor for American Public Radio, thinks that credit cards are very much a part of American society and are fine if used correctly.
“Credit cards are a part of our lives,” Farrell said. “I look at it as a nice piece of technology.”
Even though there are pitfalls with credit cards, there are also solutions to having a credit card without going into debt, he said.
“For a lot of people, a safety valve is to have a credit card with a very low limit,” Farrell said.
A safe limit for consumers is $500, Farrell said. This generally helps people control how much they put on their credit card. It also helps them to control the possible debt they could incur from going to the spending limit.
Another good way to avoid credit card debt is to get a secured credit card. With this kind of card, a consumer will put a certain amount of money in a savings account.
Whatever they put in the savings account matches their credit limit. If they default on the credit card, then the money in savings covers the debt. “It’s actually not a bad thing,” Farrell said. “It’s a nice safe tool.”
Not everyone falls into debt with credit cards. Hannah Sieling, a University of St. Thomas graduate, has had a very good experience with her credit card.
“I really, very few times, spent money on my credit card when I don’t actually have that money in my checking account to pay off pretty much immediately.”
Spieling says she never thought about spending more then she had. It has taught her many lessons on personal finances.
“It taught me a lot more about how some financial stuff works,” Sieling said. “It has helped me start to build credit … [Creditors] can see that I had a credit card for four years and that I never abused my credit on it. I’ve always been able to pay it off.”
To use a credit card responsibly, all it takes is a little discipline.
“All personal finance is nothing more than good habits,” Farrell said.