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Column: Credit cards can fool you into debt

In the mid-2000s when I talked with college-bound students and their parents, I advised three things to ensure “success in college.”

First, I reminded the students to go to class. Many professors do not take attendance, but we academics recognize that most students perform at a higher level if they attend class.

Second, I encouraged the students to join a club or some small group in order to make friends. Students who never leave their residence halls except to go to class or the dining hall tend to be unhappy and, ultimately, do not progress in their academic career.

Third, and the subject of this column, I implored students to say “no” to all credit card offers. Pre-2009, freshmen were offered everything from free T-shirts to pizzas to sign up for a credit card during the first weeks of school. They did so in droves and ended up with huge amounts of credit card debt when they left school.

Fortunately for unsuspecting students, the Credit Card Act of 2009 was passed that required freshmen (and anyone else under the age of 21) to either show evidence of income or have a 21-year-old co-sign the credit card application. No longer do the credit card companies flock to college campuses the first weeks of class!

But that does not mean students (or their parents or anyone else, for that matter) understand how to effectively use a credit card.

Most of us have multiple credit cards in our wallets. As adults we get tempted by “special offers.” Some of us use the cards in emergency situations only. A few of us are fortunate enough to use our cards for a variety of purchases each month, but pay off the balance monthly (this is really ideal).

But the majority of us purchase all sorts of items (some that we need, and some that are impulse items) each month and make the minimum payment required by the credit card company. Effectively, depending on the credit card’s interest rate, you may be paying close to two times the cost of the item purchased.

Let’s look at an example. In our example we will assume that this is the only purchase you will make on this card until you pay off the balance. As we know, this is probably unrealistic, but let’s assume this so as not to confuse the issue.

You’re a TV junkie and must have a new high-definition television set before one of your favorite events in upcoming months . You head off to your favorite store to make the purchase.

You fall in love with an $800 TV and whip out your credit card for payment. You may or may not know your credit card’s interest rate—they can range from 12 to 18 percent or so.

Let’s assume your interest rate is 12 percent. If you make the minimum payment (which is generally around 2 percent of the balance) of $16 per month, it would take you . . .drum roll, please . . . 67 months (that’s almost 5.5 years) to pay off the bill. And ultimately you would pay $1,072 for the $800 TV (the cost of the TV plus the interest).

What if, however, your interest rate was at the other end of the spectrum? Assuming an 18 percent interest rate and the minimum payment each month, you would end up paying $1,408 over 88 months (over seven years). Would your TV even still be working by then? And remember, we’ve not made any other purchases using the credit card.

So what’s the message? Please understand how credit cards work. The credit card company is in business to make money—it’s your choice how much money they make!

Make smart purchase decisions when you use cards. Do you really need that pizza/TV/vacation? Pay the cards off as soon as you can, ideally monthly. Credit cards are not inherently bad—using them without understanding how they work can be devastating to your credit worthiness.

The holidays are approaching—be smart about how you pay for your purchases. You’ll enjoy the holidays (and every day) without the anticipation of big credit card bills that will take years to pay!

This is one in a series of columns by University of Mary Washington College of Business faculty on various aspects of finance and economics as they affect our readers. Lynne Richardson is dean and professor of marketing at the University of Mary Washington College of Business.

 

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