Credit Alert: The Dangers of Overspending and Underpaying

Miles M. is one of those people who taps into the convenience of plastic by using a debit card and a check card to make most of his purchases. “It’s easier and safer than carrying cash all the time,” says Miles, 17, who will start his senior year at Gonzaga High School in Washington, D.C., in the fall.

Unlike credit cards, debit and check cards force users to limit their spending to what they have in their bank accounts, which can be a good thing. Miles, for example, has had to learn about budgeting — or making a list of expenses like food and gas that usually don’t change much from week to week — and comparing his expenses to the money coming in each week from a job or other source to see how much will be left over.

“I’ve got a good understanding about cash flow,” Miles says, referring to balancing the money he spends with the money that’s coming in. “This summer, I’m working at Rebounderz, a trampoline arena, and I just got my first paycheck. I’ve set up a budget so if I see something I want to buy, I’ll check it against my budget to see if I can afford it now or if I need to wait and save up more first.”

Good Credit, Bad Credit

You generally “won’t get into trouble with a debit card, but you also won’t build credit history” like you will with a credit card, says Karen Chan, a former consumer economics educator at the University of Illinois Extension, who now runs her own business, Karen Chan Financial Education and Consulting.

When a person uses credit, such as making a purchase using a credit card or paying a bill, the lender sends information on payment history and balances to a credit-reporting agency. The three main credit-reporting agencies are Equifax, Experian and TransUnion. The information supplied by lenders comprises a person’s credit history and is contained in an individual’s credit report. A good credit history can open up a lot of doors, since insurance companies, loan officers, potential employers and others consider credit scores when they make decisions.

But credit cards can also have a big downside. They are a form of revolving credit, or easy-to-get debt that can let you spend way more than what you have in the bank. Overspending like that can put you and any credit card co-signers — like your parents — on the hook for high interest charges and could wreck your credit score if you are unable to pay back the loan.

Ellie W., 17, is very careful about how she uses her credit card. “I got my card from Young Americans Bank, and I’ve had it for four years,” says Ellie, referring to the Denver-based bank that services people 21 and younger. Ellie will be a senior at East High School in Denver this fall.

“Before getting the card, I talked over all the aspects with my parents, and then when I went into Young Americans, they made sure I had no questions and fully explained all the parts of the credit card and how it worked,” Ellie says. “The credit card is mine, and everything I spend I pay back with money that I make from [babysitting], house sitting or working [at some other job].”

“Young Americans Bank gives approved applicants $100 cards, not cards with limits of thousands of dollars,” says CEO Rich Martinez, referring to the maximum amount of money that cardholders can charge. This serves to provide an educational space that allows for some flexibility to explore what credit use can do for them, without enabling youth to go overboard on spending.”

Still, Ellie says that controlling her spending has “definitely been the hardest aspect of having the credit card.” Ellie has a $200-per-month spending limit, and she has a phone app called Mint.com that gives her real-time updates about her account balance. “It’s great to be able to track how much I’m spending on food, gas and random stuff,” Ellie says.

She pays off the balance on her credit card in full each month, though the credit card company doesn’t require her to. A big danger with traditional credit cards is the way that they let cardholders make a minimum payment each month, sometimes as little as 2% or 3% of what they charged, says Laura Levine, CEO of Jump$tart Coalition for Personal Financial Literacy, a national organization that offers financial education and other services.

Small payments like that don’t put much of a dent into the balance due. Instead, the balance is “rolled over” into the next month, racking up high interest charges that can skyrocket the debt far beyond the original amount. Many young adults don’t set out to abuse credit cards, “but the minimum balance is very tempting,” notes Levine. So if your card has a limit say, of $3,000, you might be able to get away with paying only $60 a month. That sounds great, until you realize that much of your monthly payment goes to pay for interest charges — currently about 13.8%, according to bankrate.com — on the debt, instead of the principal, or primary debt. In fact, at that $60 a month minimum payment, it would take about 17 years to pay off a $3,000 balance. And during that time you’d end up paying about $3,200 in interest charges alone, in addition to the basic $3,000 debt.

Students Skipping Class

People in the 21- to 29-year-old age group represent the fastest-growing segment of bankruptcy filers, according to Nick Jacobs, administrator for the American Bankruptcy Institute’s Credit Abuse Resistance Education program. “Bankruptcy filings in that age group have jumped 90% since the 2005/2006 period,” he says. “While we can’t say it’s all due to credit card debt, evidence suggests that it is a good chunk of the reason.”

Stories of students skipping class because they have to earn money to pay their credit card bills suggest that credit cards are a problem for college students, adds Chan, from Karen Chan Financial Education and Consulting. “The FACT Act was supposed to limit the solicitation of teenagers by credit card companies and assure that those teens who received a card had either the income to justify approval of the application or a co-applicant who did,” she notes, referring to the federal Fair and Accurate Credit Transactions Act of 2003. “But a study slated for publication this fall indicates that has not happened. Many universities now have peer educator programs, such as the Financial Wellness Center at the University of Illinois at Urbana-Champaign, where a group of students are trained to provide financial education on topics including debt and credit cards to other students.”

Chan says that if you do get a credit card, it’s a good idea to figure out up front how you will make payments on time. Also, paying the balance in full each month “is a great way to build credit history while paying no interest for the privilege,” she notes.

Conversation Starters

How do debit cards and credit cards differ?

What is the minimum payment on a credit card balance and how can it be dangerous?

Do you think it’s a good idea for teenagers to have a credit card? Would you like to see more programs like Young Americans Bank? Why or Why not?