June graduates are about to enter a strange realm where their credit score is more important than their grade point average.
It's called the real world, kids.
"The biggest mistake college graduates make is failing to understand that what they do now has a huge impact on their financial future," says Bridget Smith, editor of LendingTree.com's Knowledge Center, based in Charlotte, N.C. "This includes the use of credit, overspending and failure to start a savings plan."
Your pay stub will tell you how much money you've got coming in each month, but unless you know how much you're spending and what you're spending it on, your income may never quite catch up to spending. Avoid that trap by drafting a budget and sticking with it. (See "Living Debt-Free.")
The key to successful budgeting is looking ahead to what you plan to spend, rather than just reviewing what you've already spent. To do this, break expenses into three main categories: needs, wants and dreams.
Many people don't understand the difference between needs and wants, as evidenced by the crushing credit-card debt many people carry. Needs are basic things, including rent, car payments, insurance, utilities, food and monthly installments on your student loan. (See "Avoiding Sticker Shock.") Such items should be taken off the top of your take-home pay each month to determine what you have left over for wants.
When you have a real job, you'll have to budget for clothes, especially fancy duds for work; grungy jeans will no longer cut it. You'll also need to set aside money for routine car maintenance or major repairs on an old clunker. File those items under "needs" as well.
Things you want but clearly don't need to survive each month include going to the movies or a ball game, eating out or buying a new camera or TV. Dreams include vacation travel, gifts and holiday spending.
If your take-home pay is $3,000 per month, and if rent, utilities and other basic expenses consume $1,200, you have $1,800 left each month for wants, savings and those things you dream about.
Establishing credit and using it wisely separates the perpetual undergraduates from the adults. First, a credit card isn't free money. Think of it as an unsecured loan from the bank that allows you to buy now and pay later. If you're smart, you'll pay the bill in full each month, using the bank's money interest-free and building a solid credit history. (See "Using Credit Wisely.")
In general, a credit score of 720 or above is excellent; 675-719 is good; 620-674 is below average; and below 620 is sub-prime, meaning you'll have a tougher time finding a lender, and you're almost certain to get socked with a higher interest rate. (See "Deciphering A Credit Report" and "Fixing Bad Credit.")
"If you've got a student loan and a credit card, you've got a credit report, and you should check it," says Smith. "You build a good credit history by paying your bills on time and not maxing out your cards. Use a credit card to help you manage your money and track what you spend, but don't use it to buy things that you couldn't otherwise afford." (See "Establishing Credit.")
Beware of offers made at the cash register by department stores or specialty retailers to open a store credit account. Many retailers offer 10% off your purchases if you open a store account on the spot, betting that they'll make up the difference and more on interest payments. Some clever grads open multiple accounts, thinking they're clever to save 10% on several purchases. But each application requires a credit check, and too many inquiries can ding your credit score, driving up the cost of future loans.
You don't need the retailer's in-house card, because most stores accept Visa or MasterCard, issued by major banks such as JPMorgan Chase, Bank of America or Wells Fargo .
If you have trouble with credit cards, don't take on any more debt or sign up for new cards. All you need is a major bank card and maybe a gasoline credit card. Cut up the rest. Each month, pay the balance due in full on every card, because the interest payments will eat you alive.
Learn the difference between "smart" and "dumb" debt. The first involves a long-term advantage, such as a student loan to complete your studies, a mortgage or even a car loan. But it's dumb to run up credit-card debt with a high interest rate for groceries, fancy dinners or entertainment. If you calculate the interest cost — the annual percentage rate on some cards is in excess of 20% — and add it to the price tag, the item often becomes prohibitively expensive. (See "Seven Credit Card Tips For College Grads.")
"Low payments on a 72-month car loan may seem affordable," Smith says. "But how many people drive a car for six years? Many people extend the payments to buy more car than they can afford — and it gets very expensive if you don't keep the car for the term of the loan."
If some money lands in your lap via a birthday gift, tax refund or inheritance, think about using it to reduce debt, especially if you've run up a balance on a high-interest credit card. If credit debt isn't taking a bite out of your monthly budget because you manage your expenses well, use the found money to open a Roth IRA. It's never too early to start saving and investing for retirement. (See "The Too Good To Be True Tax Break.")
Finally, start a savings account for emergencies. It's not enough to keep extra money kicking around your checking account with a pledge not to spend it. Set up a separate savings account and make regular, monthly contributions to it. This will give you a cushion for an unexpected expense and it will also introduce you to the wonders of compound interest.
Do the math. Small steps can build a hefty savings account over time. Even $25 per week adds up to $1,300 per year. That's $13,000 over ten years, plus interest. Think what saving $100 per week would total — or $200.