First of all, give yourself a break. Most students – and yes, most working professionals too – have very little practical understanding of personal finance. American schools often don’t teach personal finance skills and responsibility, so most of us are left to our own devices to learn the ins and outs of credit use, borrowing, and debt.
Here’s a good roadmap to help you get from zero to financially savvy in no time at all.
Step 1: Budget
Basic budgeting skills are the key to building savings and avoiding (and managing) debt. If you’re in student loan repayment or want to make a big purchase in the future (a home, for example), budgeting is an absolute must. Fortunately, it doesn’t take much to build a household budget if it’s something you’ve never tried. If you’re in student loan repayment or plan on making a big purchase in the near future, start here to get your ducks in a row.
- Keep it simple with this formula: Subtract the value of your monthly savings contribution (emergency fund/long term goals), your bills, and expenses from your monthly income. The difference, whether it’s twenty bucks or two thousand, is what you can spend on entertainment, retail, food, and other fun stuff. Ask yourself: Can I reduce any of these fixed monthly expenses? (Think about canceling cable, enrolling in an income based repayment plan on your student loans, or getting a less expensive car, etc.)
- Track your spending over time. If you’ll have more fun using an app or some spreadsheets for this, there are plenty of web-based tools available (Mint and Personal Capital are two, just to name a few). If that seems more stressful, no worries! Just take a look, at least once a month, at your spending, and note any significant postive or negative trends so you understand better where you "leak" money. Those small items we all spend money on every day turn into a really big monthly expense when purchased on a repetition basis. Going out to eat too much in the summer? Time for some dinners in with friends. Too many weekends out of town around the holidays? Cut corners somewhere else. Getting a daily latte at your local coffee shop? Brew your own at home. Here is your chance to reduce your flexible expenses.
Step 2: Credit
Now that you know how much you’re spending (and what you’re spending it on!) let’s talk about the “C” word.
- Your personal “credit” is a measure of how much companies trust you, based on your history of repayment, to pay back what you owe. Here’s an example: You swipe a credit card to buy an Xbox, fully intending to pay it off in a matter of months. Your credit card company is a lender, and they’ve issued you credit, because they trust you to repay the debt. Now, here’s how credit gets nasty. Let’s say you stop paying on that Xbox. Your non-payment is recorded as part of your credit history. Your credit score – which we’ll get to in a moment – drops like a rock. The next time you want to borrow money, your lender, and other lenders, will deny you the credit you need. Want to rent an apartment, finance a new computer, or refinance your student loans? Protect that credit history and score.
- Your credit score is based on a few specific factors, chiefly: your repayment history, the amount of money that you owe at any given time, and the amount of existing credit that you currently have. If you have no existing credit, lenders don’t know what to do with you. That’s why you “build” credit by opening a credit card. We suggest doing exactly that, but remember – never carry a balance. Use it wisely and pay it off in full each month.
Step 3: When to Borrow
When is it okay to go into debt (by using credit offered by lenders in the form of credit cards, personal loans, or other financing?) Here are some good guidelines:
- Borrowing money to pay for an education is ok. Do not borrow haphazardly. Know what your employment prospects are after graduation, and don’t throw hundreds of thousands of dollars at an education that will not produce a salary sufficient to repay that debt. It can be tough to figure this out on your own, so talk to your school’s financial aid office and professionals in your field of study, and ask some serious questions. Use online tools to research careers and salaries. Remember to pay attention to your starting salary, not the one you will make 10 years from now.
- Do not borrow money for goods and services you don’t need immediately. Do not pay for electronics, meals, or vacations on credit. Do not borrow (and that includes making purchases on your credit card) unless you have a clear picture of your repayment schedule.
You can spend a lifetime becoming a financial expert, but you’ll be far ahead of the pack if you grasp the basics of credit and lending and develop a household budget. Spend wisely and borrow smart!