- Written by Marjorie Daley, author of the New Adults’ Guide to Basic Finances.
Table of Contents
1. LoansWe touched on federal and private loans. Now is the time to expand and explain how loans work. A loan means that you borrow money with the agreement that you will repay a certain amount over a certain time frame. You pay interest to borrow the money. Interest allows the lender to make money on your loan, service the loan, and repay a bit of interest to those who lent them the money. Loans may come with fees, such as doc (document) fees or origination fees that add to the cost of the loan. ALWAYS know what you are signing and what you are expected to repay. There are two types of loans – secured and unsecured. Within those loans are specialized loans with different terms (repayment, fees, and interest rates). For right now, we are going to address three types – secured, unsecured, and predatory.
Type of Loans
- A secured loan is backed by something of value. For instance, your car loan has the car as collateral for the loan. If you do not pay the loan back, your car can be repossessed and sold to make up for what you did not pay. Secured loans usually come with lower interest rates and better terms. Secured loans include car loans, mortgages, and secured credit cards. A secured loan is a great way to start building credit.
- An unsecured loan only has your promise that you will repay the money. Unsecured loan examples include regular credit cards, student loans, and personal loans. Unsecured loans generally have higher interest rates and require credit checks. The lower your credit score, the higher the interest rates.
- Examples of predatory loans include car title loans, payday loans, and those who prey on the ignorant. Car title loans are short-term (less than a few months), high-interest loans on your car title. If you fail to repay, you lose your car. Payday loans are short-term, high-interest loans against your next payday. The interest rates on both these are usuriously high, up to 400%. This means that for every $100 you borrow, you repay $500. This trap leads you very quickly into extreme debt.
Interest RatesInterest rates come in two varieties – simple and compound. The difference is that with compound interest, you pay interest on the interest. Let’s say you take out a simple interest loan for $10,000 at 8.75% for five years. You will end up paying back $14,370. If you take out the same loan compounded monthly, you end up paying back $15,456.05. A simple interest rate example would be a personal loan. Credit cards would be an example of compund interest accounts. Interest can be compounded daily, weekly, monthly, annually, etc. Just read the loan terms carefully! Following are the formulas for both simple and compound interest: Simple Interest = P x r x n
- P = Principal amount
- r = Anual interest rate
- n = Term of loan, in years
- P = Principal amount
- r = Anual interest rate
- n = Number of years interest is applied
2. Credit Scores and Credit ReportsAn important measure of how well you do at repaying your financial obligations.
|FICO credit scores
|Very Good 740-799
|Very Poor 300-579
|Very Poor 300-499
- Payment history is the largest percentage of your credit score (35%) and 100% under your control. If you miss or are late in making payments, your score drops. If you are trying to improve a low credit score, pay your bills on time. This one action will almost immediately raise your score.
- Credit utilization ratio (30%) is also under your control. This ratio deals with credit cards and other revolving loans (loans where you can use the money over and over again) looks at how much money you could use if you maxed out your credit cards versus how much you actually owe. Your best credit utilization ratio is under 30%.
- Add up all the credit limits on your credit cards
- Add up all the balances on your cards
- Divide the balance total (#2) by the credit limit total (#1)
- Multiply by 100
- Length of credit history represents 15% of your score. You need at least six months of credit reporting to have a credit score. The older your credit history, the better your score. If you have no credit history, your credit report is “thin.” To get a score, consider taking out a secured credit card or a secured credit builder loan. A secured credit card has a savings account (collateral) behind it that guarantees you will repay the card. As long as you repay the card every month, the collateral is not touched, and you get a positive report. A secured credit builder loan puts the loan into a savings account to act as collateral. After you repay the credit builder loan in full, you get the money in the savings account.
- Credit mix means that you have a variety of loans in your history. Some credit mix examples would be car loans, mortgages, credit cards, personal loans, etc. The problem for most people starting college is they usually do not have a mix. Besides taking out a mix of loans, you can report your rent payments to Experian Boost (or pay a reporting service to do the same to all three). You may want to consider taking out a credit builder loan to add to the mix.
- The final factor is recent applications. This is also 100% under your control. Recent applications are “pulls” on your credit history. There are two types of pulls: soft and hard. A soft pull releases a limited credit report to potential employers, landlords, or for pre-screening loans. Soft pulls do not affect your credit rating. A hard pull releases your entire credit report. You have to sign a document allowing a hard pull. If you apply for a credit card, it will be a hard pull. This is why you should never apply for the store cards just to get a percentage off today’s purchase. Not only do you have another credit card to whip out and max out, but you have a hard pull that has a short-term effect on your credit score. We’ll discuss how to stop hard pull under the scams section.
3. DebtDebt is part of American life; the goal is to keep it as low as possible.
- Good debt includes the purchasing of items that increase in value after the purchase. These include:
- Home equity loans
- Student loans
- Small business loans
- Bad debt includes items that decrease in value after purchase. This includes:
- Credit card debt
- Payday/car title loans.
- Grey debt includes purchases that may be good on the surface but cross into bad debt because of poor spending habits. For instance, student loan debt means you are getting an education that will hopefully improve your life and your income. It becomes bad when you take on excessive amounts because you chose an expensive school, misspent the loans, or chose a major where the future income does not match the cost of the education. Anything that is “good” debt can easily slide from good to grey to bad with bad choices.
Types of DebtThere are five basic types of debt with a lot of crossover among the types of loans. These include:
- Revolving debt
- Term loans
- Car loan: $10,000
- Interest rate: 2.49% APR (annual percentage rate) or 0.2075% per month
- Time to repay: 5 years (60 months)
- Monthly payment: $187.42
- Total interest paid: $1245
- Total amount to repay: $11,245
4. Credit CardsA necessary evil. Use with discretion.
Credit Card TermsCredit cards come with their own terminology and understanding them can prevent unpleasant surprises. Be aware that credit cards put the good stuff in huge fonts and the important, unpleasant stuff in tiny font to make it harder to read. ALWAYS read and know what you are agreeing to. Otherwise, you will be surprised and not in a good way.
- APR or Annual Percentage Rate: How much interest you pay over one year on any charges not paid off immediately. APR is based on the prime rate plus how much risk the lender feels it is taking. You do not have just one APR, you have many! The list below includes all the APRs currently possible. Since credit card companies make their money off APRs, there may always be more in the works. These include:
- Balance-transfer APR is applied to charges transferred from another card.
- Purchase APR is charged on purchases.
- Cash advance APR is charged on cash advances.
- Introductory APR is an excellent interest rate charged for a limited introductory period.
- Variable APR changes with the prime rate.
- Fixed APR does not vary but can be changed by the lender with notification.
- Penalty APR is charged if you miss a payment or make a late payment.
- Credit Limit or Line of Credit or Spending Limit: How much you can “borrow” on your credit card as determined by your credit report. If you have a secured card, your credit limit is the amount of cash you have deposited with the credit card issuer.
- Balance: How much of your credit limit you have used and how much is revolving. For instance, if you have charged $1,000 on your card and you pay off $600, your balance is $400.
- Balance Transfer: Transferring the balance on one card to another card to get a better interest rate.
- Billing Cycle: The amount of time between one statement closing date and the next closing date, legally no less than 21 days.
- Cash Advance: Borrowing money from your credit card. Cash advances have an extremely high APR and no grace period.
- Fees: Credit cards make a killing off their fees. Not all cards have all the fees, but all of the cards have some fees! Here are a few of them.
- Annual fees – charged using the card.
- Balance transfer fees – charged on balance transfers, usually 3%- 5%.
- Cash-advance fees – 5% of cash advance or $10, whichever is greater.
- Foreign transaction fees – charged on purchases made outside the US, usually 3% of charges.Late payment fees – applied if you miss your payment date. You can be charged $29 for first-time instances and up to $40 for subsequent missed payments over the next 6 billing cycles.
- Grace Period: The amount of time between the end of the billing cycle and when your bill is due. You accrue no interest during the grace period. Grace periods do not apply to cash advances or balance transfers.
- Minimum Payment: The smallest amount you must pay each month. It is either a percentage of your balance or $25, whichever is greater. From that minimum payment, the credit card company takes out fees and interest. Anything left is applied to the amount you owe. You can, of course, pay more or all of your debt. If you get stuck in the minimum payment trap, it can take years to pay off your credit card. Let’s take a look at minimum payments.
- Credit limit: $10,000
- Interest rate: 18% APR (annual percentage rate) or 1.5% per month
- Purchase: $500
- Monthly minimum payment: $50.00
- Time to repay: 11 months
- Total interest paid: $48.63Total amount to repay: $548.63
- Credit limit: $10,000
- Interest rate: 18% APR (annual percentage rate) or 1.5% per month
- Purchase: $500
- Monthly minimum payment: $75.00 (Minimum payment plus $25)
- Time to repay: 8 months
- Total interest paid: $32.63
- Total amount to repay: $532.63
5. InsuranceAn important expenditure to protect yourself.
Life InsuranceLife insurance is a replacement for your income and goes to people who depend on you for support. There are four types of life insurance: whole life, term life, child life, and final expenses. We are going to deal with the last two first because they are pretty simple.
- Child life means that you are insuring the life of your child. Statistically speaking, the death rate for children is very low. You are (probably) not dependent on that child for income, either. The main reason to purchase child life insurance is if you have a family history of chronic illness. Rolling your child’s life insurance into adult insurance is less expensive than purchasing adult life insurance outright when you have a chronic illness.
- Final expenses insurance pays for your burial. Funerals and all the accouterments like caskets and plots are stunningly expensive and people are asked to make those decisions under difficult conditions. If you want a showcase funeral or to be buried on your motorcycle, you may want final expense insurance. Otherwise, go for the pine box or cremation and a simple container.
- A whole life policy lasts for your whole life. You pay a premium every year for a certain number of years. Once the policy is paid in full, the insurance remains effective until you die and then your beneficiaries get the money or face value of the policy.
- Beneficiaries are the people who “benefit” from your life insurance policy. The policy belongs to them. You must have their signature (i.e., permission) to take out or cancel the policy. Forging a signature is a crime.
Health InsuranceHealth insurance is a huge nightmare in the United States. The short version is that you need health insurance. You may be young and healthy, but all that can change in an instant. The long version is what kind of health insurance you can get and afford. At present, there are your choices: employer, private, Affordable Care Act (ACA)/Obamacare, Medicare, and Medicaid.
- Employer insurance is offered through your employer, and you may pay for all or part of the cost. You can get this type of insurance through your college. If a parent has insurance, you are under 26 and are a full-time student, you can stay on their insurance. Depending on the cost and quality, this may be your best deal.
- Private insurance is purchased through an insurance company and covers just you (and your dependents). Private insurance tends to be pretty expensive.
- Affordable Care Act/Obamacare is defined by the federal government and offered by private insurance companies as an option for people who do not fall into the first two categories. Depending on your income, you may be able to get part or all of your ACA insurance subsidized.
- Medicare is federal health insurance for people over 65. Medicaid is federal health insurance for people living below the federal poverty level.
- Deductible – a set amount that you pay each year. If you have a $1000 deductible, you will pay for the first $1000 of medical care every year. At that point, insurance pays between 80% and 100% of your medical bills for the rest of the year.
- Premium – the amount you pay each year for the insurance. Your deductible determines your premium. The lower the deductible, the more expensive the insurance. If you have a high deductible, you have catastrophic insurance because it will only cover you if you suffer a medical catastrophe like a serious car accident or other serious injury/illness.
- Co-pay – paid at every doctor visit. Usually, the co-pay is applied toward the 20% not covered by your insurance company once you reach your deductible.
- Cap – a lifetime limit on insurance. Let’s say that your insurance company caps your coverage at $1 million. After it spends $1 million on your care, you are no longer eligible for insurance. This may seem like a lot of money but in reality, a chronic illness or devastating injury may result in you hitting the cap. In the bad old days, if you had a child with a chronic illness or cancer, they could meet their cap in a few years and never again be insurable.
- Pre-existing conditions – any illnesses or injuries that predate your insurance coverage. This can include, quite literally, anything that has ever happened to you but are commonly cancers and chronic health issues. A COVID-19 infection may be considered a pre-existing condition in the future. ACA/Obamacare eliminated the pre-existing condition and cap situation for everyone. Unfortunately, this may change as the ACA is constantly being challenged by our federal lawmakers.
- Liability protects the other drivers in case you cause a wreck that damages their car, or they are injured. If you cause an accident, your liability insurance pays for the damages to their car or injuries to the car’s passengers.
- Collision repairs your car if you cause an accident. If the other driver causes the accident, their collision kicks in.
- Comprehensive covers your car from weather, theft, and other damages.
- Medical coverage supplements your health insurance and that of your passengers in the case you or they are injured in a wreck. Medical coverage is very important to protect you and your assets. If someone is injured in your car, in most states, you can be sued for their medical bills. Having medical will help.
- Underinsured driver kicks in if the other driver does not have enough insurance to cover the damage to you or your car.
- Limits – the amount that you are covered. For instance, you may have comprehensive limits of $5000. This means that the greatest amount that you can claim is $5000.
- Deducible – how much you have to pay before your insurance kicks in. The higher your deductible, the lower the cost of your insurance.
Other Insurance Concepts
Renter’s InsuranceIf you rent or live in a dorm, consider a renter’s policy. Your landlord’s insurance protects them in the case of an insurable event. Your stuff is not included. Renter’s insurance protects your belongings from loss, theft, water damage, vandalism, fire, smoke, and lightning. In some instances, the landlord may provide or require renter’s insurance. Read the lease before you sign it. What does renter’s insurance cover?
- Renter’s insurance covers personal possessions
- Liability (a guest gets hurt in your apartment)
- Additional living expenses.