I’d like parents of today to realise that talking to kids about money, debt and credit is as important as teaching them good manners. Good manners can’t be instilled overnight; neither can awareness about money and good credit habits.
Children must be eased into understanding the importance of money at a very young age as this will stand them in good stead as young adults. They should be made to realise that ‘credit’ is only a tool that empowers them with cash flow, but if used incorrectly, it can be a big stumbling block that can alter the course of their lives!
Today, I’d like to focus on credit cards and personal loans because for most people, debt seems to be a standard part of life and credit cards, though fairly passé, aren’t to be taken lightly.
The importance of educating kids about debt
I think it is super important to educate your kids about debt because if you don’t control it, it ends up controlling you. Unmanageable debt can ruin lives. It can have a huge impact on mental health, and in turn, impact the success of healthy relationships.
So, as a parent, if you can understand the basics of credit, you should lead by example and equip your kids with information many of us did not receive. If you follow and encourage healthy credit habits within the family, you will be setting your kids up for financial success.
Unmanageable debt can have severe repercussions and why we focus on credit cards
I think familiarising children with the concept of credit cards is particularly important because this is something that can easily get out of control. In my experience as a financial adviser, I’ve come across adults who have triple-figure credit card debt with no assets to show for it at all. The primary reason for this is the need for instant gratification and an increase in the number of people living beyond their means. It also has to do with the lack of understanding of what the ‘true cost’ of something is, after you factor in interest repayments.
When you’re looking at the use of credit cards among young Australians, statistics show that 36% of them have credit cards and don’t pay the balance off each month. The average amount owed is $2477!
I can certainly say that instant gratification and the need to keep up with the Joneses drives a lot of the spending in our consumer-driven society. What’s scary is that people don’t understand how it can impact their lives until they find themselves cornered by an insurmountable debt!
Young Australians love credit cards
A common example of when people take out their first credit card is probably to indulge themselves a little with a holiday once they’ve started working. For instance, a colleague of mine told me that he got his first credit card when he was around 21 and was halfway through his first year of full-time work. He decided to go on a skiing holiday to Queenstown to take a break and have fun. He knew he wouldn’t have had enough money saved up to pay for that trip before he went, as he had only been working for a few months. And that’s when he was lured by the convenience of a credit card.
This isn’t ideal, we should encourage kids to save for things, however badly they want it. When they start working, they have a steady income and they’ve got some savings in the bank, then it’s reasonable to consider getting a credit card with a limit based on the savings they have. If they have the savings, then no matter what, the balance can be repaid in full at the end of the month.
It’s important to make the full repayment
This is a very serious issue. If you get your first credit card at the age of 20 with a credit limit of around $5,000, you’re probably looking at an interest rate of 18%. Once you get that, you start making the minimum repayment which is probably 2%, and that works out to $100 a month. If you continue to make the minimum repayments then it’s going to take you about 33 years to repay the balance and in total repaying $17,181.
So effectively, you’ve turned a $5,000 holiday to a $17,181 holiday with no additional benefit. In most cases, the starting balance of $5000 is not maintained at that amount. It would be added to with more purchases or an additional card might be taken out. You fall deeper and deeper into the trap and you find that you just can’t stay on top of minimum repayments.
Credit is often easily accessible and that’s why people to fall into that trap and end up building the cycle of accessing more debt and not staying on top of the minimum repayment.
There are a number of other areas parents should be educating kids about regarding credit cards
There are a couple of other key areas for a young adult to consider before taking out a credit card. Most credit cards come with an annual fee that is applicable irrespective of whether the card is used or not. Some cards have a substantial annual fee while others have a limited fee or no annual fee. In the latter case, there may be a higher interest rate charged to balance that out.
Then there’s the ‘grace period’ factor. Most credit cards give you a certain amount of days to pay the bill before interest is charged on purchases. Some may not have any grace period, so you really need to check and make sure what the card structure is. The grace period only applies if you’re paying off your entire balance in full each month. Otherwise, each month interest is calculated immediately after the purchase, without the benefit of a grace period from another set transaction date.
Another trap that people can fall into is that of paying just the minimum, though the interest is being continually charged.
Accruing interest, how it impacts them and how to stay on top of it
Interest rates are expressed in annual terms even if the bills are generated monthly. Credit cards use different rates for purchases as opposed to cash advances. And the way cards work is you will likely pay down the lower interest rate balance first. What that means is, if you are carrying forward a balance each month, the payments you make are going to be made to the balance that has the least amount of interest.
Take a cash advance for example. Cash advance is when you use your credit card to pull money from the ATM, instead of your actual savings account. This is probably the most dangerous use of the credit card.
The bank charges you a fee for doing that and the interest rate charged will be much higher than what the purchase rate interest will be. So when you make a repayment, that repayment will go to the smaller interest balance, which is your purchase rate, rather than your cash advance rate. The only way to get on top is to make sure your balance is paid in full each month, otherwise you will continue to accrue a large interest cost on that card.
There is no grace period for a cash advance
There is no grace period for a cash advance; so the second you withdraw money, the interest starts accruing and that’s the primary danger of it.
Personal loans are popular with young people. Here are the things parents should be telling their kids.
Personal loans are issued by banks and credit union. There’s a set replacement schedule over one to five years. Interest rates are somewhat dependent on whether or not it’s a secured or an unsecured loan.
A common secured loan for a young person would be the purchase of a car. It’s a secured loan because it’s secured against the value of the car. A common unsecured loan for a young person would be for the payment of a holiday. As much as you may have that amazing experience, you don’t have an asset attached to the loan, which is where things can get a little dangerous.
So, for that reason, secured loans usually have a better interest rate than unsecured loans. And typically, personal loans would have a lower interest rate than credit cards. But there are additional fees and charges for personal loans which you do need to be aware of, and that’s where doing your research can make a big difference.
One of the other things you need to be aware of with a personal loan is that you’ve really got to stay on top of the agreed repayments. If you do fall behind on your repayments and you’re not able to make them on the agreed frequency, then it is going to impact your credit score, which later impacts your ability to access other loans.
If you’re buying your first car now and down the track, you want to apply for a home loan you don’t want to make getting your home loan difficult because you weren’t able to maintain a healthy personal loan when you were a young adult!
This is why kids need to understand the importance of maintaining a good credit score and good credit history. If they don’t handle their credit card or personal loan responsibly, they will regret it later on in life!
There are some tips parents can give children who want a credit card or a personal loan or even if they are considering giving kids a subsidiary card under their account
I think deciding in advance what the credit card will be used for and how it’s going to be repaid is of prime importance. Then, start with the smallest credit limit you can get on the card and make sure that is managed effectively. To do that, try and keep the credit limit to a figure that isn’t in excess of your savings, so it can be repaid no matter what.
Understanding the fine print and the additional fees involved with having a card or personal loans is also important. Repay the full balance on each payment cycle, to make sure interest does not accrue on the card. Avoid having multiple cards; that can also lead to a lot of issues. And examine your bills to make sure all the transactions are legitimate. Unfortunately, there are instances where you’ll have fraudulent activity. Just make sure you pick that up quickly and let your bank know if that happens.
It’s fair to say the starting point is to avoid credit cards, if at all possible, for kids particularly. If not, you should be very careful and use this opportunity to educate, create good habits and have a conversation about how it has to be used and the responsibility attached to it, before you actually do it.
If you’d like to learn more, we run regular workshops on a variety of topics. To find out the dates of these workshops, please visit our website at evalesco.com.au/workshops and join our healthy, wealthy, happy community!
If you wish to discuss anything raised in this blog please get in touch with me or your Adviser.
