Ant and Grasshopper Graduate From College

by Katie Day

Each spring thousands of college graduates leave the safe haven of university life for the real world. From paying off student loans to the shock of auto insurance rates, there's a host of new financial experiences awaiting these grads, and some situations for which they're totally unprepared.

Take recent college graduate Michael as an example. Michael carries a potential spending spree in his wallet: There are his Visa, American Eagle, Gap, and MasterCard credit cards. And those are only the ones he knows about. Michael doesn't even realize he has been accepted for many other credit cards from signing up at campus locations just to get free T-shirts and CDs. In addition, he regularly charges his food and textbook expenses, and also used his credit cards to finance a computer and his last spring break trip. Although he has a part-time job, most of Michael's income goes toward paying rent, bills, and entertainment expenses.

Michael is like a lot of his peers. A recent study reported by Nellie Mae, a student loan financier based in Braintree, Mass., found that 76% of college students own credit cards, a number that has increased 17% since 1998. The report also states that 71% of undergraduates use credit cards for school supplies and food.

Ashley also is a recent college graduate, but she has made some better financial decisions. Although she has $10,000 in student loans, Ashley has no credit card debt and has steadily been saving extra cash for when she needs to start paying off her debt. Like Michael, she also has a part-time job, but carefully budgets her expenses.

We'll follow both of these fictitious college grads and see how their financial paths diverge by examining their good and not-so-good financial choices.

The cost of credit

Perhaps the most unsettling surprise for recent college graduates surrounds the long-term impact that poor credit decisions can have during and after college.

To help avoid getting into credit trouble, college students and recent college grads should get copies of their credit reports to have a clear picture of their financial situations. Credit reports also can show the deep impact debt can have on credit histories, and allow you to spot any inaccurate information. Individuals can obtain a copy of their credit report from each of the three major credit reporting bureaus once a year.

In addition to obtaining a credit report, young grads also will want to regularly check their credit score. A credit score is a number from 300 to 850 used by potential lenders to determine the interest rate on loans and whether credit is granted, and at what cost.

Think of it this way:

Michael owes $5,000 on his credit cards from charging many of his food and entertainment expenses and his spring break trip to Cancun. He pays only the minimum balance on each of his credit cards and has been late on payments. As a result of a poor credit report and low credit score, Michael pays more for his car insurance, is required to pay a larger security deposit for his apartment, and even has missed job opportunities and graduate school acceptance.

Ashley pays off her credit card balance each month, pays her bills on time, and obtains a free credit report each year from each of the three major credit bureaus. Because of her clean credit report and high credit score, Ashley has a low interest rate on her car loan, qualifies for low interest credit cards, and recently has qualified for a mortgage with a low interest rate.

It's never too early to start saving for retirement

One of the most serious mistakes young grads can make is to put off saving for retirement. Those in their late teens and early 20s may think that planning for retirement makes little sense, considering that it's an event that won't take place for another 40 years. But retirement is a process as well as an event. What occurs in the many years that lead up to retirement has a profound effect on the quality of retirement once it arrives.

Take a look at the numbers.

Ashley starts saving for retirement at age 25, and puts $2,500 a year into her retirement account. At age 65 when she's ready for retirement, she has earned an average of 6% interest and her account is worth $437,376. Michael starts later, when he's 35. He's also earning 6%, but to have the same amount in his retirement account by the time he turns 65, he would have to save $4,865 a year. So start early--and take advantage of retirement plans like 401(k)s, 403(b)s, and/or IRAs (individual retirement accounts) that give you the benefit of tax-advantaged compounding.

Also, most employers provide a matching contribution--the employer will match your contribution up to a certain percentage. Try to contribute up to the current allowable limits because your contributions automatically lower your taxable income--and your early start gives you years to benefit from compounding.

Save for a rainy day

Many financial experts recommend you have three to six months of your salary and income put away in case of an emergency or unexpected expense. It's important that this money be liquid, which means that you can withdraw it without penalty at a moment's notice. You also will want to earn as much interest on it without incurring risk, which may make a money market account your best option. While you'll never lose the money deposited into this account, you're not guaranteed to increase the value either.

To help build her savings, Ashley has her paychecks directly deposited into her savings and checking accounts and also has money set aside via payroll deduction for extra savings. Because she has been able to save up for an adequate emergency fund, Ashley's extra payroll deductions allow her to afford a large down payment on a car she has wanted to buy.

Michael does not have an emergency fund and has been finding it hard to save for one because of his hefty credit card bills. Although he is slowly paying back his credit card debt, he has been turned down for an affordable auto loan and doesn't have the funds to pay for necessary maintenance on his car.

Affording your first house

After five years of working at similar jobs with similar salaries, both Ashley and Michael want to get out of renting and build equity by buying a house. Ashley is looking at a house in the price range of about $160,000 and is prepared to put a 5% down payment of $8,000 on a house. Because of her clean credit report and high credit score, Ashley is quickly preapproved for a 20-year mortgage with a low interest rate.

Because of Michael's poor credit report and high credit card debt, several financial institutions have turned down his request for a home loan. The only one he qualifies for is a mortgage at a very high interest rate. In addition, Michael does not have any money saved up for a down payment. Because of this, he decides to put off buying a house until he has a better handle on his finances and can improve his credit score. His fianc�e Lisa is pretty disappointed about this--but her credit situation is the same as Michael's. And there's no way they can swing the big wedding and honeymoon they both want.

Making informed financial decisions early on can have a huge impact on financial opportunities in the future. Poor financial decisions in college and soon after can have long-term implications. Remember, credit is a great tool, if used responsibly. Make sure to keep credit card debt to a minimum and don't forget to start thinking about saving for retirement early on. A poor credit report and low credit score can hinder important financial milestones such as buying your first house and car. And remember, too, that the people at your credit union are ready to provide the services and support you need--as you get started and as you move through life.

January 16, 2006