by Carol H Cox
No, it’s not too late to talk to your soon-to-be-graduating high school senior about personal finance! In fact, now is a great time to begin the conversation. My parents never had these talks with me when I was graduating from high school, but I also wasn’t facing tens of thousands of dollars of student loans in my future either, and credit card debt wasn’t the huge problem it is today.
Managing money well is now more important than ever. The average college grad leaves school with about $28,500 in student loan debt, and the average American struggles with over $6,900 of credit card debt carried from month to month.
You don’t need to be an expert to give good advice to your child, and you don’t have to have your finances in perfect working order either. We’ve all screwed up our finances on more than one occasion. It’s tough for us parents to admit that we’ve made money mistakes, but these may be some of the best teaching lessons. They’re real. They’re memorable.
Life is messy. It doesn’t follow neat little rules—although financial experts sure like to draw them up. So take comfort in knowing you’re not alone. Many Americans are in difficult financial situations, like too much debt, flabby credit scores, savings deficits, and the like.
Now, where to begin?
Below are some important basic topics to address with your teen. (Click on highlighted text for additional information.):
1. Checking Accounts:
Checking accounts are incredibly useful and convenient for holding short-term cash and paying bills. Every young adult needs to consider getting one. Even though check writing is not nearly as common as, say, ten years ago, it’s also good to know how to write one. TheBalance.com website provides a great basic visual explanation of check writing.
Checking accounts usually provide an ATM/debit card option with the account, allowing the cardholder to withdraw money from ATMs or make purchases with the card. Accountholders can avoid ATM fees by sticking with their bank’s networked ATMs.
Debit cards do not involve debt. The funds used to make purchases come from the checking account linked to the card. Of course, accountholders need to regularly track transactions into (deposits) and out of (withdrawals) the checking account to avoid overdrawing the account (trying to spend more money than is currently available in the account). Banks and credit unions charge fees for overdrafts, eating away at accountholders’ cash balances.
2. Budgeting:
Call it a spending plan if you like, that’s what a budget is, a means of planning for, tracking, and targeting the flow of income and expenses (including savings) that a person has. There are many ways to set up a budget. The best one for any individual is one that she or he will actually use, so a simple plan is usually best to start.
A popular uncomplicated one is the 50/30/20 budget for allocating an individual’s after-tax income. This rolls off the tongue nicely, but really the order needs to be reversed. First, 20 percent of after-tax income is set aside for savings (emergencies, retirement, car/house savings, etc.) and any debt obligations (ex: auto loan). Next, 50 percent of the person’s income is allocated to necessities, and finally, 30 percent goes towards the individuals “wants” (discretionary spending).
When referring to necessities, we’re talking about things like insurance, rent, utilities, gasoline, grocery food, transportation costs, and Internet service. For discretionary spending think movie/TV streaming services, music subscriptions, dinners out, concerts, coffee shop spending, cable TV, and so on. There are a number of free apps available to help with budgeting, such as Mint.
3. Credit Scoring:
When a consumer borrows money from an organization, whether it be by way of a credit card account, student loan, or auto loan, the company will keep track of the consumer’s credit activities and transmit this information to credit bureaus. Think of credit bureaus as data storage warehouses that compile credit-related behavior data on millions of consumers. This information is used to calculate consumers’ credit scores. The standard FICO credit score ranges from 300 to 850. The higher the better.
Plain and simple, credit scores will determine how much a consumer is charged in interest on loans, may dictate other things such whether a landlord chooses to rent to an individual, the terms of a cell phone contract, or a prospective employer may ask to access an applicant’s score. Organizations frequently use a person’s credit score as a means of gauging an individual’s trustworthiness. Like it or not, it’s true.
There are five behavior factors that go into calculating a person’s credit score, and each factor has a percentage weighting:
- Responsible payment history (35% weighting).
- Credit utilization (30% weighting).
- Length of history (15% weighting).
- Credit inquiries (10% weighting).
- Type of credit held (10% weighting).
The first two make up 65% of factors that go into determining the score. So getting these two right will get an individual nearly two-thirds of the way there.
Having a responsible payment history means that the consumer pays bills on time every month. Setting up automatic bill pay from a checking account, automating the payment process, helps an individual avoid late payments. A person can also keep a calendar of bill due dates to keep track of bill payments.
In addition, the credit utilization ratio needs to be kept low in order to gain and maintain a good credit score. For example, if a person has a $5,000 credit limit on a credit card account and she or he has $500 outstanding on the card that month, then the credit utilization ratio is 10% on that card ($500/$5,000 = .10). Credit experts vary on their opinion of what is appropriately low, but the range for a reasonable overall credit utilization seems to be around 10% to 30%. The lower the better.
The remaining three factors, length of history, credit inquiries, and type of credit held are the last 35% of factors that go into scoring. Basically this means that it’s generally best to keep open older credit accounts, to not submit lots of applications for credit cards or loans, and to have a variety of types of credit accounts.
4. Credit Cards:
Whereas a debit card is linked to an account that has previously been funded with money, a credit card allows an individual to essentially borrow money to be paid back at a later date. The credit card company pays the merchant for the consumer’s purchases and then the consumer pays back the credit card company later.
Interest charges will be added to the credit card account for any outstanding balance after the grace period has passed, at least 21 days. This means that the accountholder is not charged any interest on purchases made with the card if the individual pays back all charges within that billing period, by the bill due date.
An individual who pays off her or his credit card account balance every month can avoid sinking into credit card debt.
Credit card accounts are an important part of a consumer’s credit history as well. Always paying bills on time and in full, as well as not using too much of the allowed credit limit will help an individual build a good credit score.
5. Student Loans:
And last, but not least, you’ll want to discuss student loans with your child. Young adults want to limit student loans as much as possible. Loans provide a way of paying for something today by making a promise to repay the money plus interest in the future. If students take out too much in loans, they can seriously overburden themselves with debt, greatly impacting their flexibility in the future. This can impact lifestyle choices, such as career selection, where to live, whether or when to buy a house, whether or when to get married, and many other decisions that involve money.
To be eligible for federal student loans students must complete the Free Application for Federal Student Aid (FAFSA) each year.
Repayment on federal student loans usually begins six months after an individual has graduated (exceptions are made for persons continuing on in school or those on active military duty). The standard repayment period is 10 years, and the interest rate is 5.05 % as of this writing.
If the loan is a subsidized student loan, interest does not begin accruing on the loan until the borrower’s six-month grace period is over (the grace period typically begins after graduation or if the student falls below half-time status). If the loan is unsubsidized, the loan balance will begin accruing interest as soon as the loan is disbursed, and these charges are added to the loan balance.
As an alternative to the standard repayment plan, federal student loans also offer income-driven repayment plans, which may allow the borrower to lower their monthly payments by basing payments on her or his annual earnings level. However, lowering monthly payments will also lengthen the term (number of years payments are to be made), 25 years being the maximum loan term.
Total federal student loans for undergraduates is currently capped at $31,000. Students considering taking on debt need to realistically consider their future occupation and how much they expect to be earning. There are several student loan calculators available and websites with salary information that can be used as a starting point. Making out a future budget and seeing how loan payments would fit into the picture is important.
There are also private financial institutions that offer student loans, but the interest rates tend to be higher or variable. Also, they do not have the same flexible income-driven repayment plans available, and often credit checks are required, so a co-signer is usually needed along with the student. Consider private student loans as a last resort.
Here are some tactics for limiting the need for student loans:
- Choosing less expensive colleges to attend.
- Starting at community college and transferring after two years.
- Searching out grants and scholarships.
- Working while in school.
- Finding organizations to shoulder some of the burden in exchange for service later (ex: Reserve Officers’ Training Corps (ROTC) or companies who help employees pay off student loans in exchange for years worked).
It’s important for high school students to understand banking, budgeting, credit, and student loans, before leaving home. They need a good grasp of these important financial topics to create a sound foundation for successful money management.
Your money discussions with your child can be ongoing, continuing throughout the young adult years. Over time they will surely expand and include topics other than those touched on above. What’s most important now is that you start before your child’s financial life becomes more complicated.
So go ahead, begin the conversation.
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