Financial Savvy Helps in the ‘Real World’
With stories of rising tuition rates, cuts in student loans and questions about whether higher education is a good investment or not, those entering college this year have a lot of worries on their plate.
“College is where students start to feel financially responsible,” said Farnoosh Torabi, a personal finance expert at Credit.com. ”Whether they like it or not, they step into a new world of dollars and cents. It can be very overwhelming.”
To help soften the landing into this new financial world, MainStreet rounded up some of the financial jargon that can help you lessen your financial concerns, for college and the future.
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Get rid of the negative associations you may have with the word “budget.” You don’t have to live off TV dinners and ramen, avoid shopping for clothes or confine yourself to your room because you can’t afford to go out with friends.
“We've all taken to using the term in a manner that is synonymous with deprivation,” said Laura Levine, executive director of the advocacy group Jump$tart Coalition for Financial Literacy. “But a budget is really a plan, a guide, for how you're using your money.”
By approaching the process with a focus on what you can buy with your income rather than what you can’t, a budget will empower you while at the same time help you avoid increasing your debt. Levine recommended that students create a budget by examining what living expenses and school costs they can afford.
“It doesn't matter if the money comes from Mom and Dad--the budget will help the student make it last,” Levine said. Photo Credit: RambergMediaImages
The CARD Act
The Credit Card Accountability, Responsibility, and Disclosure Act, or the CARD Act, is an important piece of legislation that was passed in 2009 to help consumers manage their credit cards and put an end to some of the unfair practices of card companies and banks.
According to the new law, only people 21 years and older can sign up for a credit card without a co-signer or proof of sufficient income. However, many banks are still opening accounts for people under the age limit, and Torabi adds that many are still signing up young people for credit cards based on their student loan income.
“Even though you get a monthly payment, it is not meant to be spent on a credit card,” she said.
The CARD Act was created to avoid a situation where banks prey on young adults’ impulsive behavior and spending habits to lock them into debt.
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Credit vs. Debit
It’s actually two important words that you should know - credit and debit – but understanding the differences is what’s key here.
A debit card draws from the money in your checking account.
Using a debit card is good practice for managing your spending, Torabi said. It helps students be aware of what they have so that they can spend wisely. “If you can prove that you are responsible with a debit card, it’s a good sign that you can manage a credit card,” she said.
The main distinction of a credit card is that it has to be paid off after the purchases have been made. Credit cards are important for establishing your credit – proving that you can borrow responsibly and pay off what you owe – which can help you later in the future when you try to take out loans for a car or house.
Susan Knox, author of Financial Basics: A Money-Management Guide for Students, said that credit cards also offer more recourse than debit cards if you suspect that your card number has been stolen and used by someone else. “If you have a problem with a purchase, you can go through the credit card company and you usually have a little more leverage,” she said.
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When you try to make a purchase with a debit card but don’t have enough money in your checking account, your bank can charge anywhere from $10 to $35 in overdraft protection fees to let the purchase go through. In most cases though, it’s usually a case of not knowing how much cash you have rather than spending more than you should.
College students are more likely than others to overdraft their accounts at least once, Torabi said. She recommends that students call their bank and opt out of overdraft protection even though it might mean that when you get to the cash register you will get rejected if you don’t have enough money in the bank.
“When you get embarrassed once at a store, that’s a pain that will make you more conscientious of your spending,” she said, adding that refusing overdraft protection will help keep students more disciplined and aware of what they’re spending, which will ultimately help them save money. After all, every time you get charged a $35 overdraft fee, that’s $35 less to spend on things you actually need or want.
Knox said that students need to understand what they’re getting charged for: New account holders should not only read their contract, they should also sit down with a bank representative and run through all of the financial scenarios they may encounter, which will inform them about monthly fees, ATM withdrawal charges and any costs in lost or replacement cards.
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Credit Scores and Reports
If you want to rent an apartment, buy a car or take out a student loan, your credit report and score are going to be two of the most important factors in whether you are allowed to borrow. Students should know what’s on their reports, especially if they are planning on further education, since universities have picked up the trend.
“Professional and graduate schools check your credit score, particularly medical schools,” Knox said.
Torabi adds that many students are not aware of their credit profiles when they open up a credit card. “As they go ahead in life and they’re looking for a car loan, a place to rent, or an additional credit card, their credit score can be a determining factor in the eligibility of loans,” she said.
On the other hand, your credit report is a reflection or history of your credit score. This includes how promptly you pay your bills, how well you manage your debt, how many credit cards you have and if you ever have a delinquent account.
Each year, everyone is entitled to a free credit report from each of the three big credit rating agencies: Equifax, Experian and TransUnion, available at AnnualCreditReport.com.
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Private vs. Federal Student Loans
With rising tuition rates, prospective students are bound to ask for financial aid. One of the important distinctions they should understand is the difference between grants, scholarships and student loans. Grants and scholarships are given to students based on a variety of factors like academic performance or leadership skills, and they do not need to be paid back.
Student loans, on the other hand, must be paid back and they will earn interest until they are fully paid off. These loans can be both private (lent by a bank) and federal (lent by the government). Federal loans come in various forms like the Stafford, Perkins or Parent Plus loans and charge lower interest rates than private loans. That lower interest comes at a price though, as federal loans are capped at certain amounts depending on the level of schooling the funds are used for.
“Federal loans are a little better-structured than private loans,” Torabi said, adding that they generally offer a fixed interest rate and more flexible payment options such as deferment or income-based repayment.
Private loans are only limited by the borrower’s credit history, but they may have floating interest rates and less-favorable repayment terms than federal loans.
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Newbies to the workforce, beware. You’ve probably heard your parents talk about “death and taxes” and you’re about to learn why.
“If you’re working, you need to understand that the salary that’s quoted is not what you are taking home,” Knox said. “You only receive about two-thirds of what employers say you get as a salary.”
That remaining third goes to taxes, including federal income tax, state and city taxes, a Federal Insurance Contributions Act (FICA) tax, Social Security contributions, and if your employer offers a health care plan that you have not opted out of, you will be charged a bit for that, too.
Photo Credit: Andres Rueda