Growing up, I always thought getting a credit card was one of the biggest milestones of adulthood. However, I did not fully understand what it meant to own a credit card and the burdens that come with it. The allure of swiping for purchases, earning rewards, and building a credit history can be tempting, but the responsibilities accompanying this plastic piece are often underestimated.
Before writing this blog post, my understanding of credit cards was quite basic. I knew you could spend money on a loan if you paid it back on time. After conducting thorough research, I can now say I have a much better grasp of credit spending and the myths surrounding credit cards. I hope this blog post will have a similar effect on you, the reader, so you may confidently approach the world of credit spending.
Understanding Credit Card Basics
Paying It Back
Understanding how to repay a credit card is pivotal in responsibly managing your finances. When you make a purchase with your credit card, you’re essentially borrowing money from the credit card issuer. Most credit cards offer a grace period, typically around 21-25 days, during which you can pay off your balance without incurring any interest.
If you pay the entire balance within this grace period, you won’t be charged interest on the borrowed amount. However, if you carry a balance beyond the grace period, interest will accrue on the remaining amount.
Let’s break it down with an example: Imagine you purchased $100 worth of groceries on your credit card. If you pay the entire $100 within the grace period, there’s no interest. However, if you only pay $50 within the grace period, interest will be applied to the remaining $50 until it’s fully paid off. This underscores the importance of timely payments to avoid the potential financial burden of accrued interest.
Suppose you went out with your friends and bought $50 worth of fast food using your credit card, and you choose to only make the minimum monthly payments. If your credit card has an annual interest rate of 18%, and you let the payment sit, you’ll owe $9 extra after a year. This may not seem like much, but if you add another purchase of $25 from Winners, then $30 at H&M, and so on, you could spend hundreds of dollars on interest just because you used a credit card to pay for them.
Financing
At some point in your life, you may end up financing something costly like a car or an expensive television. Financing is the process of providing or obtaining funds to support a purchase, typically with the understanding that the borrowed amount will be repaid over time, often with interest.
Let’s say Alice wants to purchase a car worth $20,000, but she doesn’t have the full amount upfront. Alice approaches a bank for a loan to finance the vehicle. The bank approves her for a 5% interest rate loan over a 5-year term. Using a loan calculator, the monthly payment for a $20,000 loan at a 5% interest rate over 5 years is approximately $377.42.
After the 60 months, Alice will have paid $22,645.20. While the payments are more manageable, she will end up paying over $2,600 more than the cost of the car, which is no small sum! Additionally, cars are depreciating assets, meaning that while you pay for the car, it’s losing value.
Incentives
In terms of credit cards, incentives are mechanisms that reward users for spending credit. Credit card companies offer various incentives, including rewards points, cashback, and other benefits. For more information on choosing the right card for you, click here.
It’s important to remember that the better the reward may seem, the steeper the consequences of not paying it back. Credit card companies are businesses trying to make money, not looking out for your best interests.
Consequences
Failing to pay back your credit card can lead to serious consequences. Initially, missing a payment may result in late fees and an increase in your interest rate. This can negatively impact your credit score, making it more challenging to secure favourable terms for future loans.
If you continue to miss payments, the credit card issuer may report the overdue payments to credit bureaus, further damaging your credit history. Persistent non-payment may lead to debt collection efforts, including calls and letters from collection agencies. In extreme cases, legal action may be taken, potentially resulting in wage garnishment (in Ontario, creditors can take up to 20% of your salary to pay back the debt) or asset seizure, where the bank will repossess things like your car or house.
The long-term consequences include a tarnished credit report, limited access to financial services, and increased difficulty in securing loans or mortgages. It is important to recognize when you may be facing consequences and speak with a financial professional to avoid them.
Conclusion
Whether you are in high school, college, or university, you are likely to encounter credit cards if you haven’t already. In the realm of personal finance, wielding a credit card comes with great power and responsibility. As we wrap up the questions surrounding credit cards for young adults, it’s essential to acknowledge the potential risks and rewards accompanying this financial tool.
The journey toward financial security is an important one, from understanding interest rates and financing to adopting responsible spending habits. With this newfound knowledge, young adults can confidently navigate the credit card landscape, making informed decisions that pave the way to a secure and prosperous financial future.
Remember, a credit card is not merely a piece of plastic; it’s a gateway to financial independence, and by using it wisely, you can have a brighter financial future.
About the Author
My name is Mark Kazenelson, and I am a high school student in the Greater Toronto Area. I have a passion for chemistry and I will study chemical engineering as I prepare for a career in the energy sector. As a high school student, I explored many career options and put together a series of career-related blog posts. Check out my other blog posts on engineering and medical school. I hope these articles can help inform students in their career decisions. In my spare time, I love spending time outdoors, especially fishing and hiking.