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Money Management Basics, Part 6
Credit Cards and Student Loans Are Not Free Money
Millions of college students blow it big time when it comes to taking on credit card debt and student loans. I don't know how it happens. Actually, I do know at least part of the cycle with credit cards. You walk on campus and a credit card marketer is there, saying something like: "Hey, want a free T—shirt?" All the student hears, pretty much, is the word free.
Sure, you know that you've got to pay back the bank for all those charges you make. But for most students, that's a distant concern. They're enchanted by the idea that they can (in their own minds) get something free today, simply by slapping down a piece of plastic at a department store or retailer of their choice. But credit cards are anything but free—and neither, of course, are student loans.
In fact, using the word credit for people in college is a particularly egregious misnomer. The word credit often has a positive connotation for college students. You've all heard the expression, "I give him credit for doing this or that." And what about college students who love to get "extra credit" from professors? As you can see, in most contexts, the word credit gets used positively among students, and that's the time at which many people are most unsophisticated, vulnerable, and likely to get tripped up by using credit the wrong way. But it might help you to think about a credit card as what it really is: an IOU card.
None of this is to suggest that credit is inherently a bad thing or that you should not have credit at all. For many people, having credit allows them to function in society in a seamless way, and to use credit as a convenient method of payment. Credit cards enable us to do everything from shop online to rent automobiles. So the idea isn't to say, "I'm never going to use credit cards again," especially if you have had a financial problem. The challenge is to determine: "How can I manage my credit cards well and what should I be doing to make sure that I am a smart and savvy consumer in order to leverage my credit standing in a way that gives me the most benefits?"
Not only are credit cards and student loans not free money, they are borrowed funds that can actually be quite costly if not properly managed or if allowed to linger on year after year. With credit cards, you're really getting an up—front loan to pay for various purchases, so in this manner, credit card debt and student loans aren't that different. They're both fundamentally loans.
And for the privilege of receiving that loan, you'll pay dearly in most cases. The typical credit card has an interest rate of about 15 percent. That means for every $100 you charge, you'll pay an extra $15 on top if you take a year to pay the bill. If you miss a credit card payment, you could find yourself in the unfortunate predicament of having a "default" interest rate, which now runs as high as 35 percent on some cards. While most federal student loans offer single—digit interest rates at less than 9 percent, if you stretch out your student loan payments (as most college grads do), you can wind up paying two to three times your original student loan amount because of interest charges alone!
With that credit card, you'll also face a slew of charges, such as annual fees, cash—advance fees, finance charges on the outstanding part of your bill, late payments, and over—the—limit penalties.
Don't ever accept a credit card offer or student loan without a very good idea about how you will repay it and how long that repayment will take. Too often students simply think, "Oh well, I'll worry about that bill later." That's not smart financial planning, and it's the easy way to financial ruin. One reason for that is you'll probably take on more student loans and more credit card debt than you anticipate. Remember the first lesson, "Everything always costs more than you think it will"? Well, the same thing is true with your educational costs too.
Why would higher education cost more than you estimate? A big reason is that many of you mistakenly think you'll finish school in just four years. Those days are long gone. Students take an average of 6.2 years to complete their degrees in public universities, and 5.3 years to graduate from a private school, according to the Conference Board. For those who aren't conscientious about the debts they take on, this means additional student loans and more credit card debt racked up along the way.
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Education is one of the most basic right of any human, but with the increase in prices and the costs involved in education this has made these rights turn into a privilege which very few can enjoy. Any normal person today in the whole of United States has to take an education loan at one point of time to pay for their education fees.