The American education system does not provide an adequate financial education for 74% of high school students, leaving college-bound kids unprepared for what lies ahead. Only 13 states require students to complete financial courses as a requirement for graduation, compounding the problem.
Despite the lack of access to financial courses, students showed an eagerness to learn. In a recent poll conducted by Sallie Mae, 84% of students wanted to increase their knowledge regarding finances. Instead of receiving a financial education in the classroom, 86% of the students surveyed learned from financial mistakes after entering adulthood.
Before getting your child situated in their college dorm, prepare them for independence by teaching them the following financial principles:
How Loans Work and When to Borrow
Before the first day of class, students typically sign loan documents, borrowing money to pay for their higher education. Without a grasp of lending practices, students may incur debt without a clear understanding of the legally binding contract.
Making wise borrowing decisions include understanding loan terms and contract language. Finding effective ways to keep costs down can mean borrowing less, paying attention to interest rates, and understanding repayment requirements.
Not all debt holds the same value. Furthering education can be good debt if it serves as an investment. Credit cards tend to fall under bad debt because students often use cards to purchase wants rather than needs and it comes with high rates of interest.
Teaching students to evaluate these factors can lead to strategic borrowing, rather than living beyond their means.
Loan Factors Which Impact Borrowing Costs
Interest rates represent the cost of borrowing money. In general, the lower the rate, the better, but it is not the only consideration. Students should also consider how often interest compounds, the monthly payment, and the time it will take to repay the debt.
Longer repayment terms can lead to higher costs. At times a lower rate, over a longer period, can cost more than the shorter-term option, at a higher rate. For example, borrowing $15,000 for a vehicle at 5% for 72 months will result in a monthly payment of $241 and total interest paid of just over $2,393. Changing the loan to 48 months, at a higher rate of 6%, still lowers borrowing costs to $1,909 but raises the monthly payment to $352. The second loan will shave off two years of payments and result in less interest.
Loan calculators can help determine the best route by comparing rates, repayment schedules, and the impact of compound interest on the debt.
To Get a Credit Card or Wait
Parents and college-aged children like the convenience of student credit cards. They tout the benefit of access to emergency cash and the ability to build credit before entering the workforce. The challenge is that most students do not use credit cards only for emergencies, nor do they pay them off every month. Instead, they purchase impulse items, live beyond their income, and run up debt before graduation. Receiving a credit card too early can lead to poor buying decisions and destroyed credit before beginning a career.
The Wall Street Journal published a balanced article to help weigh the pros and cons of credit cards for college students.
Develop A System to Manage Finances
College is typically the first time a student must cover their expenses. Even if the parent and school cover the majority of living costs, they will still make daily decisions about money. Do they buy pizza or eat in the cafeteria? Make coffee in their room or buy it at the local coffee shop? First-year students must manage finances to pay for things, including food, transportation, laundry, and toiletries.
Whether your child receives loan proceeds, income from a part-time job, or an allowance from mom and dad, they must learn to live within their income. To make the job easier, help students create a monthly budget and provide stipends in short intervals.
They can use smartphone finance apps to track spending and practice managing a checking account.
Unless it’s an emergency, if your child runs out of money, do not run to the rescue. Always rectifying financial mistakes do not teach them appropriate money management skills. Small mistakes now can lead to a better understanding of finances and prevent future mistakes.
Discuss ways to reduce spending, along with strategies to save money, leaving a cushion each month for unexpected costs.
The Importance of Credit
Taking out student loans is often the beginning of credit for college students. Using a credit card can also build a track record of repayment, which will work for or against them, based on the payment history. Credit is an essential step in adulthood and will impact the ability to make large purchases, obtain a phone or utilities, rent an apartment, and in some cases, to get a job.
Earnings and taxes go hand in hand and children need a working understanding of how and when to file taxes, along with relevant deductions and credits that can save them money.
Other relevant tax knowledge includes understanding social security and Medicare tax withholdings and the difference between gross and net pay. They can begin implementing tax strategies from the initial tax withholding form completed at the start of a new job.
How to Cook
Cooking and finances have a direct correlation because food costs are among the most flexible items in a budget. Students can learn to stretch the budget by learning to cook basic meals.
Instead of eating three meals each day on the meal plan, reduce food costs by cooking in the dorm or apartment. With a crockpot and microwave, there is a host of inexpensive meals that only take a few minutes to prepare.
Your child can learn to cook a few favorite meals to stay healthier, eat out less, and significantly reduce food costs while in college.
Another cost saving strategy is getting additional roommates. Sharing a room divides nearly all living costs, including rent, utilities, and internet. If roommates cook and ride together, they can also lower food and transportation costs.
There are many components to managing finances in college. Leaving home with essential financial skills will create a stronger knowledge base and allow your child to live better on less.