As I mentioned in this post, I am a professor. But, what I haven’t shared yet is that I’ve been teaching a freshman seminar on personal finance this semester. Just to be clear, I am not a finance professor or any kind of finance professional for that matter.
However, I got an opportunity to teach a freshman seminar on a topic of my choosing. Naturally I chose to discuss personal finance since most people’s financial education is virtually non-existent.
It’s been fun to teach and I like to think the kids are learning at least something in the class. We’ve talked about a variety of topics thus far, and I thought I’d write a few posts about topics I’m discussing with my class, and some observations I’ve made while teaching it.
Without further ado, here’s the first installment in a series I’m calling Freshman Finance. I’ll start with a basic overview of what I taught them about the subject, then list some of the questions they had, and end with observations on their comments and reactions.
Credit cards are not free money. When you see a credit card in your wallet you should be thinking, “that’s a loan waiting to happen.” A credit card is a standing offer of a loan from the credit card’s issuing bank. The size of the maximum loan you can take out is called your ‘credit limit’ on the card.
Credit cards can be a great way to build credit. The reason is that you don’t have to pay any fees or interest to build your credit, unlike an installment loan. However, that benefit goes away the minute you begin to carry a balance on your credit card. Let me explain.
Carrying a balance refers to not paying all of the money that you owe on the credit card at the end of the month. If you pay back all the money you borrowed throughout the course of the month, then you don’t have to pay any interest. That’s a pretty sweet deal.
So why are all the big banks offering free loans to everyone? Because they know that most people won’t pay the full amount at the end of the month.
See, when you spend money on the card, you’ll get a bill that tells you how much you owe. The total will be in regular text. Then you’ll probably see something called the minimum payment: a much smaller dollar amount that is written in bold to get your attention.
You might be tempted to only pay the minimum balance. Don’t. As soon as you pay the minimum balance rather than the full amount owed on the card, you get charged interest on all the money you borrowed. Without going into too much detail, the bank calculates your average daily balance for the month and then applies a set interest rate (usually 20%+ for people with little or no credit) to that balance.
The bank knows that people will want to pay the minimum, which means that the bank will make money on most of the loans.
By the way, that’s how banks make money. You give them your money in a savings or checking account and they pay very little or no interest to you, and then they loan out your money to other people for much higher interest rates, pocketing the difference. But I digress…
There’s basically only one thing to look for if you are signing up for your first credit card. You want a card that has no annual fee. An annual fee is charged for some cards if they come with a lot of fancy bells and whistles. But if you are getting your first card, you want one that won’t cost you any money. Because, ideally, you will never close this account.
Credit scores are a topic for another day, but part of your credit score depends on how long your credit accounts have been opened. This means that you want that first account to be open from now until you die, essentially. That means that you don’t want to be paying for the account for all those years.
That’s essentially it for the basics. Credit cards are a free loan if you are disciplined and a nightmare if you treat them flippantly. If you get one, just make sure you pay the balance in full every month and you’ll be fine.
Q: I’ve heard that you have to carry a balance on your credit card to build your credit score. Is that true?
A: NO. Definitely not. Your credit will be affected exactly the same if you pay the money back the next day, or if you just pay the minimum balance forever. The only difference is that it’s free if you pay it off every month.
Q: Do I have to spend a lot of money on the card to build my credit?
A: Again, NO. It’s just a box that gets checked that says you paid on time. The box doesn’t care whether you paid $1 or $10,000, it only cares whether or not you were on time.
Q: What if I sign up for a bunch of credit cards and then rack up a bunch of debt and then settle it in court for a fraction of the cost. Can I make money that way? (I seriously got this one in class)
A: FOR THE LOVE OF GOD, NO!!! Please, please never try to do this. Also, stop watching so much damn TV.
Q: What’s the best card to get for someone who doesn’t have good credit?
A: Any card that doesn’t make you pay an annual fee is fine. You won’t get a good rewards card with bad credit or no credit, so just try to get one that doesn’t make you pay a fee to own it.
I was pretty surprised at how little the class knew about credit cards. They didn’t even know that they represented loans. This is a serious oversight by society in general. How in the hell are young people supposed to know better if they don’t even understand that the plastic represents a loan?
Of course, the information is readily available, but geez. If you’ve got kids, please talk to them about money.
See you for the next installment, young Padawans.
Are you surprised by the questions they asked? Do you have any feedback for what I should emphasize if I teach this course again?