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Welcome to the wonderful world of credit! Now that you've graduated, you are probably like most graduates and are beginning to manage your own finances and build credit. While entering the credit world is exciting, it can also be challenging. One of the best ways to avoid mistakes is to be aware of the challenges you may face. Here are five top credit challenges for recent college grads.
1. Falling Prey to the "Buy Now, Pay Later" Mentality
When you've spent your whole life making purchases with cash or a debit card, the idea of money not coming out of your checking account when you swipe your credit card can be very alluring. It's easy to think, "I'll just pay for this later when the bill comes." But sometimes when later comes and you've had that thought too many times over the course of the past month, you're left unable to pay off your balance in full. This can put you on the fast track to credit card debt if you're not careful, especially once interest starts building on the remaining balance you were unable to pay when the bill came.
When you're first getting into the world of credit, it's best to train yourself only to charge what you can pay off at the end of the month. Try not to think of it as paying later. In fact, you may even want to pay off each purchase you make on your credit card as you make them.
2. Not Understanding How Credit Scores Work
Not many of us were taught about credit scores in school. Therefore, many young adults don't know much about their credit score. Before venturing into the world of credit, it's worth learning more about that three-digit number. Details that make up the score, like payment history, credit utilization ratio, hard inquiries and other factors, are essential to be aware of. It's also beneficial to know why you should want a good credit score. Taking out a mortgage or buying a car may not be your top priority now, but you may have those goals in the future—and you'll need a good score to achieve them. Getting into good credit habits now can help you maintain that desired score throughout adulthood.
3. Thinking You Only Need to Make the Minimum Payment
When you get your first credit card bill, you'll see the amount you owe for that billing cycle. It'll be a number that's less than your balance. But that's only the minimum payment you owe. And while paying it on time every month is important and adds to a good credit score, paying more than your minimum payment—ideally your full balance—will do a lot more to help your credit.
In addition, if you're being charged interest on your balance, paying only the minimum payment won't get you too far in keeping your debt totals low. The minimum payment may just barely cover the interest charged from that month and result in a higher balance each month. As a result, you won't really make a dent in the balance owed or lower your debt-to-income ratio, an important factor in good credit. If possible, it's best to pay off your full balance each month. If not, paying down as much as you're able to can prevent you from sliding down the slippery slope to unmanageable debt and a low credit score.
4. Being Enticed by Flashy Offers
When you're shopping around for credit cards, you'll see a lot of flashy promotional offers. Often these include a zero-interest introductory rate or an enticing rewards bonus. You can certainly use these to your advantage, especially when building credit for the first time. However, it's essential to know that this will not be your credit experience forever and will require management on your part to avoid a messy result at the end of the promotion period. Be sure to read the details of any card you apply for, including the introductory interest rate and post-introductory period rate (which will be considerably higher) and how that will impact any balance you leave on the cards at that time. Rewards are appealing, but they still cost, so know before you spend.
5. Closing Inactive Cards
If you've paid off a balance on a card and are no longer interested in keeping that account active, it may seem like a good idea to close the card altogether. However, this can actually hurt your credit score. Closing an account affects your credit utilization ratio, which measures how much you owe versus how much credit you have access to. Closing an account decreases the amount of credit available to you.
Additionally, the length of your credit history factors into your credit score. Closing an account, especially an older one, shortens the length. You would need to weigh the drop in score to the number of accounts you have open. The drop in credit score may only be temporary and a small change, making it worthwhile to close old and non-used accounts. But another idea, if you can resist temptation and are not paying high fees on the card, is to put your card away in a drawer, or even cut it up, and not use it.
Beginning your credit journey can be both exciting and a little overwhelming. It's OK to make mistakes—and most people will along the way. Knowing what you're getting into before you sign up for new credit is the best way to educate yourself on the ins and outs of credit and how it impacts your personal situation. With a little knowledge in your back pocket, you'll be well-prepared for the world of credit.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.