What Every College Student Should Know About Finances Part 2: Financial Concepts

• Written by Marjorie Daley, author of the New Adults’ Guide to Basic Finances.

Welcome back to part 2 of our series on What Every College Student Should Know About Finances and we are glad you enjoyed  Part 1: Choosing and Paying for College

Table of Contents

1. Loans
2. Credit Scores and Credit Reports
3. Debt
4. Credit Cards
5. Insurance
6. Summing It Up

Loans, credit scores, debt, credit cards, and insurance are very important to understand and to use effectively to help your college plans.

1.  Loans

We 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.

The final category of predatory loans includes salespeople who make promises that they can fit you into a more expensive car or cellphone than you intended to buy. My youngest is an active-duty Marine and many of the businesses around bases are very aware that these young Marines are great targets for predatory sales. My son went into a cell phone store and walked out with a new cellphone having signed paperwork that he did not read for an amount he does not know for terms he cannot state. I was so annoyed with him that I wrote The New Adults’ Guide to Basic Finances.

Interest Rates

Interest 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

Compound Interest = P×(1+r)t−P

• P = Principal amount
• r = Anual interest rate
• n = Number of years interest is applied

To get the best terms, you need to have a good credit score and credit report. Next, we’ll take a look at how they are calculated and how to increase your score.

2.  Credit Scores and Credit Reports

An important measure of how well you do at repaying your financial obligations. You’ve probably heard about credit scores on ads and seen clickbait articles about raising your credit scores instantly. It may seem like a mysterious number awarded to you by Them, but it is actually a simple concept that indicates how well you are doing repaying your bills. Here’s how it works. Three main companies provide credit reports. These are Transunion, Equifax, Experian. Anyone you borrow money from reports to at least one of these companies. They then use a scoring algorithm developed by FICO or VantageScore to give you a number. Because the three companies get different data and use a slightly different algorithm, your scores will vary slightly among the three companies. However, the scores are ranked as follows:

FICO credit scores	VantageScores
Exceptional 800-850	Excellent 781-850
Very Good 740-799	Good 661-780
Good 670-739	Fair 601-660
Fair 580-669	Poor 500-600
Very Poor 300-579	Very Poor 300-499

If you are getting your first credit report, you should see a score range between 500 and 700. If it is on the low side, you need to take a look at how you are repaying your bills. The scores are based on five factors that measure your ability to repay a loan and how safe the lender can feel making you a loan. The two main factors, representing more than half of your score, are under your control. These are payment history and credit utilization score.

• 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%.

Here’s how to calculate your credit utilization ratio :

1. Add up all the credit limits on your credit cards
2. Add up all the balances on your cards
3. Divide the balance total (#2) by the credit limit total (#1)
4. Multiply by 100

Let’s say you have $10,000 in credit limits but owe $2500. Your CUR is 25%. If it is over 100%, you have (hopefully) made an error somewhere. To increase your credit utilization ratio, pay down your revolving loans. This is one way that credit improvement companies can “improve” your score. They get your credit limits raised. The problem with that is that it only opens up the road to more debt. The next three factors together carry the remaining 35% of your score. These are the length of credit history, credit mix, and recent applications.

• 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.

Now that you understand where your credit score is coming from, you need to check it. You are entitled to one free credit report a year from each of the big three. Experts recommend getting one report every four months – for instance, in January, you request a report from Transunion, in May you request one from Experian, and then in September from Equifax. The following January, you repeat the request sequence. To get your free report, contact:

• TransUnion
• Experian
• Equifax

When you get your report, examine it closely. If you find errors, you can report them and have them removed from your report.

3.  Debt

Debt is part of American life; the goal is to keep it as low as possible. Debt is part of American life. In part, it is because the cost of living has risen far faster than income. The other part is because we are sold a lifestyle through media and influencers that involves spending a lot of money on stuff. As a result, people under 35 have an average of $67,400 in debt. Of that, 20% is credit card debt and 21% is accounted for by student loan debt. If you are reading this article, hopefully, you are trying to limit both your credit card debt and your student loan debt. Debt is defined as money you borrow that allows you to purchase items. Debt can be divided into three categories: good debt, bad debt, and grey debt.

• Good debt includes the purchasing of items that increase in value after the purchase. These include:
  • Mortgages
  • Home equity loans
  • Student loans
  • Small business loans

• Bad debt includes items that decrease in value after purchase. This includes:

• • Clothing
  • Appliances
  • Entertainment
  • Vehicles
  • 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 Debt

There are five basic types of debt with a lot of crossover among the types of loans. These include:

• Secured
• Unsecured
• Mortgages
• Revolving debt
• Term loans

If you remember, a secured loan has collateral backing it – a car loan is an example. An unsecured loan has no collateral backing it. Student loans are an example. Mortgages are a special type of secured loan that involves large sums of money and long repayment terms. Revolving loans are credit cards (unsecured) and other loans that may be secured that involve a set limit and you use that money but repay it with interest and then can reuse the loan. Term loans are personal secured or unsecured loans that have a set period to repay all the money. An example is a car loan or a student loan. As we discussed earlier, you will have fees and interest. Fees are either paid upfront (mortgages) or rolled into the amount of the loan. Interest is money that you are charged to borrow money. It can be simple or compound. With a simple loan, you repay the principal and interest, and the cost remains the same for each payment. For instance: you take out a simple car loan:

• 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

It is far easier to get in debt than to get out of debt. For people under 35, student loan debt is one of the most common forms of debt. We are now going to discuss the second most common form of debt, credit cards.

4.  Credit Cards

A necessary evil. Use with discretion. Credit cards are convenient and accepted almost everywhere. You need one to rent a hotel room, buy an airline ticket, or rent a car. They are far safer to use online than debit cards and safer to carry than wads of cash. They are also easy to use and easier to abuse. First, let’s look at what a credit card is. A credit card is a revolving, secured, or unsecured compounded monthly loan that you access using the card. As with all loans, you apply, and the credit card company looks at your credit report to determine your credit limit and interest rate. When you use a credit card, you use part of that credit limit and then must repay it.

Credit Card Terms

Credit 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

This example assumes that you have no late fees or penalties, otherwise, the length of time and interest would take longer and be more. Now, let’s assume that you pay an extra $25 a month.

• • 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

You save about $16 and pay it off three months sooner. Even better is to use your credit card for purchases and pay it off immediately. Remember that credit cards are compounded monthly, which means you pay interest on the previous month’s interest, old purchases, and new purchases. It adds up very quickly.

5.  Insurance

An important expenditure to protect yourself. Insurance is an institutionalized gambling racket. Basically, you take out insurance so that if something bad happens to you, you will not be financially ruined. The insurance company sells you insurance hoping that nothing bad happens to you. Insurance companies employ statisticians called actuaries who have your risks calculated to several decimal points based on your age, gender, location, and job. The higher risk you are, the more you pay the insurance company. This is not an exhaustive list of insurances. These are arguably the most important or most common. Let’s look at types of policies and then some terminology.

Life Insurance

Life 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.

Now, on to whole and term life.

• 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.

Whole life insurance has some pros and cons.  A pro is that whole life comes with a savings account. Out of every premium you pay, part goes toward the policy and part into the savings account. Brokers will tell you this is a great option because you can borrow against it. A con would be that you get to repay the borrowed amount with interest and when the insured dies, the savings account goes to the insurance company. Term life insurance is taken out for a certain amount of time and then expires. You pay the premium, but you get nothing back if you do not die within that term. Term life rates are much lower than whole life because it is only for a limited duration. If you have a child, you may want to consider term life for yourself. For instance, we had term life insurance that covered me until my children turned sixteen and were technically able to care for themselves while their father worked. Had I died before they turned sixteen, the money would have covered the cost of replacing me in terms of housekeeping, chauffeuring, and tutoring. My husband’s term life continued until both children turned nineteen and were (technically) able to support themselves. For various financial reasons, we did not need to replace his income after the children turned nineteen, otherwise, we would have considered whole life insurance on him. There are some exclusions when dealing with whole or term life. Suicide and murder of the insured by the beneficiary generally do not result in an insurance payout. There may be others. Read the policy carefully. Is life insurance a valid expense at this time? If you have dependents, consider a term life policy. Otherwise, hold off.

Health Insurance

Health 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.

If you have health insurance, you pay for the insurance. You also get to pay a deductible and a copay. Here are some health insurance terms you need to know:

• 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.

Thanks to ACA/Obamacare, the next two concerns were dropped. However, this may change in the future. I mention them so you can understand what you hear on the news.

• 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.

Another important issue about insurance is that eye and dental care is not included and must be purchased separately. You need health insurance regardless of your age or health status. It is actually easier to get insurance if you are already insured.

Car/Vehicle Insurance

Car insurance is a must-have. It protects you and your family. That’s the short version… My first piece of advice is this: if you plan to go out of state for school, call your car insurance company and make certain that your insurance plan will cover you in that state. Here are two cautionary tales. My college student attended a college in another state and took a car licensed in Wyoming. Our then-current car insurance did not cover the car in that state because we, the owners, did not live in that state. Even though the car was licensed in Wyoming and insured in Wyoming, it was technically living in Missouri, according to that company. We ended up changing insurance companies and the problem was eliminated. The sister of a college-aged friend owned a car that had been licensed in Colorado. She registered the car in Wyoming but continued to pay the premiums on the Colorado insurance. She was stopped for a traffic violation and charged with failure to maintain insurance because her insurance company did not cover Wyoming registered cars.  The sister was charged with a misdemeanor and faced jail time. She ended up with a court appearance, legal fees, and a fine. ALWAYS call your insurance agent and make certain your vehicle is covered when you go off to college before you find out the hard way! Some states do not require insurance, some do. Let’s skip all that and say that you need car insurance regardless of your state. Vehicle Insurance Terms

• 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.

If your car is leased or financed, you are required to have liability, collision, and comprehensive on your car until it is paid in full. Because cars and other vehicles lose value, insure your car for collision, comprehensive, and under-insured for the amount they are worth.

• 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

Because insurance companies know the risk they are taking insuring you, your insurance rates will vary with age. If you are a male driver under the age of 25, your insurance rates are much higher because statistically speaking, you are more likely to be in an accident. If you drive a subcompact, your insurance rates will be lower than if you drive a sports car because statistically speaking, subcompact drivers are less likely to cause an accident than someone in a sports car. If you rack up the speeding tickets and traffic violations, your insurance will go up because you are a risk to the insurance company.      

Renter’s Insurance

If 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.

Most policies cover your stuff regardless of where it is stolen, for instance, if your laptop is stolen while you are on campus. Insure your belongings for their value and then document them with photos and sales receipts. Insurance will not pay out for what you cannot prove. You can purchase additional insurance, known as riders if you choose. These are medical payments to others and extended coverage for really expensive items like high-end jewelry. There are other riders as well, but these are the most common.   

Accidental Death and Dismemberment Insurance

Accidental death and dismemberment insurance pay out for certain covered deaths, but not all. Since accidental death and dismemberment is statistically very low, this is generally not a great expense. The odds are that you are not going to die from an accident in any given year. Dismemberment insurance covers loss of all or part of a limb, hearing or eyesight, or becoming paralyzed. While these can be extremely expensive injuries, they are also very rare. For most people, this is probably not a good deal. If your employer offers this for free, take it.  

Disability Insurance

Disability insurance covers some of your physical or mental disabilities, some illnesses, or injuries and miss work for an extended period. Read your policy to understand what is covered. Disability insurance will cover 50-60% of your income. There are two types of disability insurance: short-term and long-term. Short-term disability will pay for up to a year for a qualifying illness or injury. Long-term disability can replace part of your income for months or years, depending on your policy. The cost is generally 1 to 3% of your annual income for either. If you think a disability policy sounds like a good idea, purchase long-term disability. Otherwise, take 1% to 3% of your income and invest it against a short-term disability. 

6.  Summing It Up

This is a very basic description of financial concepts, but it is a good start. While you are learning your future trade, take some time to educate yourself on retirement, taxes, records retention, and investing. Related:

• What Every College Student Should Know About Finances Part 3: Spending Your College Money
• What Every College Student Should Know About Finances Part 4: Legal Concerns