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Credit cards are simple, right? You charge stuff and pay it off - what's so complicated about that?
Module Transcript
Besides the fact that you can quickly charge more than you could easily repay, credit card companies also charge interest on your balance. It is possible to avoid interest if you pay off your entire balance each month, but if you don't, interest will be added to the amount you owe, and that amount will start to grow.
One of the most common problems students have with credit cards is that they fall into the minimum payment trap - confusing their ability to make the minimum monthly payment with actually repaying their debt. Believe it or not, making just the minimum payment means you may end up paying 3 times more than the amount you originally charged!
Here's a good example of how interest works. Say you've charged a total of $2,000 and then stop making new charges. If your card has an interest rate of 19% and a typical minimum repayment policy of 2% of your balance per month, it will take you more than 22 years to pay off the card.
How is that possible? Even though you pay off 2% per month, the amount you owe grows each and every day because of interest - your 2% really just pays the interest and a tiny fraction of the principal. And not only does it take a very long time to pay off the debt, but it gets expensive - the interest charged will be nearly $5,000, making the original $2,000 actually cost you $7,000!
And unlike many education loans, in which interest may be deferred until graduation and is tax deductible (please consult your tax advisor), credit card interest starts as soon as the charge is made. Being a student gets you no extra benefits from credit card companies.
Coupled with much higher interest rates than education loans, it's easy to see how credit cards could become a serious problem - if you're not careful.
Paying off a large credit card debt can a long and unpleasant experience, especially when your debt was incurred for non-emergency items like meals, entertainment, and new clothes. Some students have even been known to skip classes to work off their credit card debt… not the college experience most of us imagine.
The best strategy for dealing with debt is to simply avoid it - stick to your budget and pay off any credit card bills immediately. Remember, if you can eat it, drink it or wear it, it probably should not be paid for on a credit card.
The problem with debt is that it rarely happens all at once - little by little your credit card balance increases until one day you discover it will take months or even years to pay it all off.
If left unchecked, all cases of chronic debt have the same result - your credit rating is ruined and banks, credit card companies, and other lenders deny you credit.
Get ready to be called at dinnertime by collection agents, and attempts to finance a car or home in the future - even if you have paid the debt - may be refused.
Now that you understand the gravity of this situation, we have good news. Following your budget and recognizing the warning signs of excessive debt can help you avoid debt problems.
If you're worried about debt, save this section to your My Money page for trouble signs and for debt reduction strategies. And remember - your school's aid office may be able to help you out of a bad financial situation and help you avoid credit card debt.
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