by Gary Foreman
How can I get my daughter to learn the importance of savings and managing her money? My teen-aged daughter, in spite of my trying, doesn't want to know. She earns more than enough to pay her bills, but she is always broke and has trouble making payments. She doesn't know where the money goes. How can I reach her before she is trapped in the credit crunch?
Bill is right to be concerned about his daughter. The average college student graduates with more than $20,000 in debts. The problem is severe enough that the National Conference of Bankruptcy Judges (NCBJ) has launched a program that provide middle school, high school and college students some facts about credit and debts.
There is one simple fact that most people ignore about debt. When you borrow money, you must pay it back plus interest owed. So if our average student owes $20,000 and is charged 10% interest, it will cost them $2,000 per year.
Or look at it another way. At $20 per hour, Bill's daughter (we'll call her Cindy) would have to work 100 hours enriching her creditors.
But, here's the kicker. If instead Cindy saved that $2,000 every year for forty years (say in an IRA) and earned the same 10% on the money (the average stock market return for the last century), she'd accumulate just under $1 million!
Being in debt is like having financial cancer. At first, it only hurts a little. The "monthly minimums" don't seem so bad. And you can brag that you're borrowing at low introductory rates and building a credit history. But, the total balance and the minimums are likely to keep increasing. By the time Cindy graduates from college, she'll have over $3,000 in credit card debts if she's a typical student.
The next big move is when she finances a car. The salesperson is helpful. They make the payments very affordable by stretching out the life of the loan. And she doesn't intend to keep the car for five years anyway. So she figures she'll never have to make those last payments. And besides, her best friend just bought a new car so it only seemed fair.
Things seem to be going along ok. Her balances increase, but she's able to afford the minimum payments. The credit card companies must like her because every time she approaches her credit limit, they increase it.
Then one day there's a problem. She looks at her credit card statement and they've boosted her interest rate to 18%. They say it's because her last payment was late. She's furious because it's really the post office's fault. But there's not much she can do about it.
She can still make the minimums, but the higher interest rate caused her balance to grow each month. Cindy thought about cutting her spending, but somehow just couldn't stick with it.
After awhile, she decided that the best thing was to get out of those car payments. She really wasn't that happy with the car anyway. And a different car with lower payments would leave more money at the end of the month for the credit cards.
But despite the ads, it wasn't as easy as she expected. She owed more on her car than it was worth. Remember those last few years of car payments that she didn't think she'd have to make? Well, she either had to make all of them now at trade-in or be prepared to add the amount still owed to the new car loan.
About 25% of all trade-ins are "upside down" with most people adding about $3,000 to their new car loan. Lenders know that if they're forced to repo the car that they won't get all of their money back. So they jack up the interest rate a couple of percent.
That's when Cindy realized that she was probably stuck in her old car and her old car payment. It was impossible to get a car she'd like with a lower payment unless she agreed to six years or more of payments. Ouch!
At this point, she's trapped in debt. Each year more of her time is spent working just to pay her interest charges. And unless she makes serious cutbacks on her spending, she'll always remain in debt.
Worse than that, it won't take much for her to fall behind in her bills. A temporary job loss, short illness or major auto repair could trigger a crisis. And once she starts falling behind, her interest rates will skyrocket at the same time that her credit rating plummets. Generally, the only way out at that point is credit counseling or bankruptcy.
Oh, you're probably wondering why we called our girl Cindy. Because she's the anti-Cinderella. Instead of going from rags to riches, she's managed to turn a promising future into a pumpkin. The way to a happy ending? Get out of debt as soon as you possible can.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.