Post-graduate course: Dealing with credit
card debt
By Greg
McBride, CFA • Bankrate.com
 The
rising cost of education leaves many students with no choice but
to borrow the money needed for tuition. Fortunately, student loan
rates are at record
lows. Unfortunately, other expenses are frequently paid for
with a credit card, where there is no such thing as locking in a
permanent low fixed rate. The double-digit interest rates and prevalence
of penalty rates and fees can pose a significant financial hurdle
for young graduates.
How widespread is the accumulation of credit card
debt by students? According to Nellie Mae's 2002
national student loan survey, the median balance -- meaning half
had higher balances and half had lower balances -- of all students
with credit cards was $1,600. These balances accumulate as students
often rely on credit cards to finance the college nightlife, trips
to college bowl games, spring break, or even day-to-day expenses such
as food and beverages. But Nellie Mae's survey also reports that 27
percent of students had used a credit card to fund undergraduate study,
at least partially. The median balance for students who used a credit
card for educational costs was understandably higher, at $3,400. Of
this group, 40 percent had a balance greater than $5,000 when leaving
school.
As many college graduates eventually find out, life
is expensive. Consider the household startup costs graduates face
in the years following graduation -- professional wardrobe, new
apartment, new car and furniture, to name a few. Lugging a debt
load early in life is a barrier to a better lifestyle, either by
limiting future spending, increasing reliance on borrowing, or restricting
savings for retirement and more immediate needs.
Graduates with a median credit card balance of $1,600
at an interest rate of 15 percent -- not unheard-of for young people
with a limited credit history -- would have to pay $78 every month
for two years in order to retire the balance. Graduates who relied
to some extent on credit cards for tuition expenses would need more
than five years of those payments to retire the $3,400 balance.
Repaying a $5,000 balance at 15 percent would require monthly payments
of $100 for approximately 6.5 years.
Students may be skeptical of the longer-range impact
of incurring debt, particularly if the debt can be dispatched with
seemingly reasonable payments within a few years. But consider the
following examples of how repaying that debt during the initial
working years delays progress toward other financial goals. If the
$78 monthly payments were instead invested in a money
market account yielding 2 percent, a savings cushion of $1,900
would result after two years. Diverting $78 per month into the same
money market account yielding 2 percent for five years adds $5,000
to a down payment for a first home. Instead of repaying a $5,000
credit card balance in $100 monthly increments, the same $100 per
month for 6.5 years would add $110,700 to his or her retirement
savings by the time the 22-year old graduate reaches age 59 1/2.
Let's not ignore the ramifications of delinquency
or bankruptcy that may be incurred as a result of that debt. The
consequences of bad credit habits can be far-reaching and can encompass
more than paying higher interest rates, being hit with punitive
fees, or encountering difficulty in obtaining credit for years to
come. Poor credit could lead to higher auto insurance rates, difficulty
in renting an apartment, and can even turn off prospective employers.
Starting out adulthood with credit card debt poses
many financial obstacles in later years. For some, incurring this
debt is unavoidable. Regardless of the circumstances around which
the debt was incurred, repaying it should be a top priority.
Greg McBride is a senior financial
analyst for Bankrate.com.
For advice regarding your specific
situation, please e-mail one of Bankrate.com's
Q&A experts or visit the Personal
Finan ce Advice channel on Bankrate.com.
|
