In today’s world, it’s tempting to put everything on your credit card and live above your means. That accessibility is what has led to Experian discovering that consumers in their 20s and 30s have up to $27,251 of debt. This debt is in the form of credit cards, auto loans, and student loans.
Learning about money at an early age can help you become a financially responsible adult. This is especially important during your teenage years and into young adulthood.
Teaching Financial Literacy to Teens
Getting your first paycheck is a feeling you will likely never forget. But with this newfound financial freedom comes responsibilities. If you are not well educated on how to manage your finances, you can put yourself in a tough spot, even at a young age. Being financially literate sets you up for success that you can benefit from for the rest of your life.
Knowing how to pay bills, manage student debt, and save will make the world of a difference. You must understand financial literacy, and most people don’t learn it in school. This knowledge helps you differentiate between what you want and what you need. It also teaches the importance of money and how it can impact your life. Most importantly, it helps you stay away from debt.
Looking for ways to learn about financial literacy? Check out some of these ideas from Bonvenu Bank:
- Chores - start to earn your own money by helping around the house.
- Setting up a bank first account - explore the ins and outs of having a checking or savings account.
- Savings goal - set a goal to save up for something you want to purchase. Use Bonvenu Bank’s Savings Goal Calculator to make a plan to reach that goal.
- Budgeting - sit down with your parents and put together a zero-based budget.
Types of Debt
Debt is outstanding money that is owed by one party to another. Borrowers must repay this amount to the lender, along with agreed-upon interest. Being in debt has a list of implications, including a lower credit score, potentially higher interest rates, and of course inevitable stress.
A good place to start is understanding the two types of debt, consumer debt and investment debt.
- Consumer debt is the amount of debt that is owed after purchasing consumable goods that do not appreciate. This type of debt is used to fund consumption, not investments. Of the two, this type of debt would be viewed as “bad debt”. An example of this would be running up your credit card bill by going shopping or getting your nails done.
- Investment debt is a large amount of money that is borrowed from a lender, like Bonvenu Bank, to invest in something, and it is expected that this debt will pay for itself by appreciation. An example of this would be taking out a mortgage for a home.
The Cost of Debt
At some point in your life, there is a good chance that you will be in debt, which is why it is important to understand the cost of debt. First you need to know what interest rates and annual percentage rates (APR) mean.
- Interest rates are a portion of the loan that the borrower has to pay the lender in exchange for receiving the loan.
- APR is the cost of the loan incurred over a year, including interest and some fees.
- APRs and interest rates are the same for credit cards, but lenders calculate them differently for loans.
Another important topic to understand is compound interest and how it may affect the amount of debt that you have. Compound interest is the interest that you have to pay on your balance and on the interest that your balance has incurred. So you are paying interest on your interest. Credit cards and compounding debt can create a recipe for disaster. If you don’t pay off your full credit card bill, you will then owe the amount that you spent plus the interest charges. As these charges pile up, you end up having to pay interest on the full total of what you owe, not just the amount of money that you put on your credit card.
Good Debt vs. Bad Debt
Not all debt is bad, which is why it’s important to understand the difference between good debt and bad debt.
- “Good debt” is debt that increases your net worth or has a future value. Some examples of good debt are mortgages and student loans.
- Mortgages are known to be the best type of good debt because they enable you to have a roof over your head and it’s likely that the value of your home increases year after year. Student loans can also be a good kind of debt because education will likely lead you to a higher-paying job. Of course, this depends on the industry that you go into, so make sure you do your research beforehand.
- Bad debt is debt that you don’t have the money to pay for and doesn’t increase your net worth or have future value. Anything that loses value the moment you purchase it is bad debt. For example, running up your credit card to buy clothes you don’t really need, taking trips you can’t afford to pay cash for, and buying that new electronic device that you can’t truly afford.
How much debt is too much?
Before we get into how much debt is too much, let’s first cover what a debt-to-income ratio is. Debt-to-income ratio is the amount of debt that you have, compared to your income. You can figure out what your ratio is by dividing your monthly debt payments by your monthly income before tax. The common rule of thumb is that you do not want your debt-to-income ratio to be over 43%, because then it is seen as a red flag to potential lenders. Obviously, the lower your debt-to-income ratio is, the better.
If your ratio is on the higher side, it would be helpful to seek professional help to bring down your debt.
Managing Debt
The best way to keep your finances on track from an early age is to have a personal solid plan to manage your money.
- A good place to start is to make a budget. You can do this by determining how much money you think you’ll be bringing in for the month, as well as any money you have to pay for things like your cell phone or your car. Whatever money you have left over, you can budget for things you would like to buy, do, or save for!
- It is smart to save a portion of the money that you are making each month to start growing savings in higher interest accounts like money market accounts and CDs. Keeping track of all your expenses will show you areas where you need to pull the reins back on your spending.
If you find that you are in debt at some point, two common techniques in managing debt are known as snowball and avalanche.
- The debt snowball method was made popular by Dave Ramsey, the host of a popular finance radio show. The way this method works is you pay all the minimum payments on your debts and pay them down, from smallest to largest.
- The debt avalanche method is more focused on interest rates. With this method, you are paying all your minimum payments and working on paying down the debt with the highest interest rate first. You then go down the line in order of interest rates, highest to lowest.
10 Tips for Avoiding Debt
If you want to avoid being in this situation altogether, then you need to follow these 10 tips for avoiding debt:
- If you can’t pay for it with cash or your debit card, then you can’t afford it.
- Set a budget and stick with it. No exceptions.
- Keep track of all your purchases, big and small.
- Do not live beyond your means.
- Wait 24 hours before making a bigger purchase so you can really think it through.
- Avoid “buy now, pay later” offers.
- Always pay more than the minimum due, if possible.
- Don’t “keep up with the Joneses”. You need to be the owner of your financial life.
- Use your credit card like a debit card – and pay it off every month.
- Keep an emergency savings fund.
Teenagers and young adults need to prioritize their financial education. Learning how to manage money when you're young can lead to more success and less stress in the future. Learning what debt is, how to avoid it, and how to manage it will encourage you to make smart decisions, so you won’t be drowning in debt and can be a financially healthy adult. For more ideas on managing your money, contact us at Bonvenu Bank or visit a Louisiana branch.
