Post-graduate course: Dealing with credit card debt

By Greg McBride, CFA • Bankrate.com

The rising cost of education leaves many students with no choice but to borrow the money needed for tuition. Fortunately, student loan rates are at record lows. Unfortunately, other expenses are frequently paid for with a credit card, where there is no such thing as locking in a permanent low fixed rate. The double-digit interest rates and prevalence of penalty rates and fees can pose a significant financial hurdle for young graduates.

How widespread is the accumulation of credit card debt by students? According to Nellie Mae's 2002 national student loan survey, the median balance -- meaning half had higher balances and half had lower balances -- of all students with credit cards was $1,600. These balances accumulate as students often rely on credit cards to finance the college nightlife, trips to college bowl games, spring break, or even day-to-day expenses such as food and beverages. But Nellie Mae's survey also reports that 27 percent of students had used a credit card to fund undergraduate study, at least partially. The median balance for students who used a credit card for educational costs was understandably higher, at $3,400. Of this group, 40 percent had a balance greater than $5,000 when leaving school.

As many college graduates eventually find out, life is expensive. Consider the household startup costs graduates face in the years following graduation -- professional wardrobe, new apartment, new car and furniture, to name a few. Lugging a debt load early in life is a barrier to a better lifestyle, either by limiting future spending, increasing reliance on borrowing, or restricting savings for retirement and more immediate needs.

Graduates with a median credit card balance of $1,600 at an interest rate of 15 percent -- not unheard-of for young people with a limited credit history -- would have to pay $78 every month for two years in order to retire the balance. Graduates who relied to some extent on credit cards for tuition expenses would need more than five years of those payments to retire the $3,400 balance. Repaying a $5,000 balance at 15 percent would require monthly payments of $100 for approximately 6.5 years.

Students may be skeptical of the longer-range impact of incurring debt, particularly if the debt can be dispatched with seemingly reasonable payments within a few years. But consider the following examples of how repaying that debt during the initial working years delays progress toward other financial goals. If the $78 monthly payments were instead invested in a money market account yielding 2 percent, a savings cushion of $1,900 would result after two years. Diverting $78 per month into the same money market account yielding 2 percent for five years adds $5,000 to a down payment for a first home. Instead of repaying a $5,000 credit card balance in $100 monthly increments, the same $100 per month for 6.5 years would add $110,700 to his or her retirement savings by the time the 22-year old graduate reaches age 59 1/2.

Let's not ignore the ramifications of delinquency or bankruptcy that may be incurred as a result of that debt. The consequences of bad credit habits can be far-reaching and can encompass more than paying higher interest rates, being hit with punitive fees, or encountering difficulty in obtaining credit for years to come. Poor credit could lead to higher auto insurance rates, difficulty in renting an apartment, and can even turn off prospective employers.

Starting out adulthood with credit card debt poses many financial obstacles in later years. For some, incurring this debt is unavoidable. Regardless of the circumstances around which the debt was incurred, repaying it should be a top priority.

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