There’s a long-standing debate about which is best when it comes to teaching young adults about good financial habits – debit cards or credit cards.
Debit cards allow young adults to carry less cash and teach them to spend only what they have in their account. Credit cards, on the other hand, allow them to build a credit history and increase their credit rating, which can be essential for buying expensive items later, like a house or a car, or even for start a business. However, both payment methods have drawbacks. So we asked experts to find out how young people can best use these tools.
Here are edited excerpts from our discussion with Lisa Bedell, operations manager of a team of finance professionals at Moneta Group Investment Advisors LLC in St. Louis; Kerry Jackson, partner and director of financial planning at Fish & Associates in Memphis; and Alex Klingelhoeffer, wealth advisor at Exencial Wealth Advisors in Oklahoma City.
Where to use what
WSJ: Are there things young people should specifically use debit cards for and how should they use them? them?
Mrs. Jackson: Using a debit card gives young people the autonomy to manage their own cash flow, create a spending plan, and learn how to budget. Healthy cash flow provides a solid foundation for any financial plan, so starting with a debit card is a great first step towards good long-term financial habits. You don’t build credit that way and you only deal with money, but I don’t see that as a downside; more like a first step on a financial roadmap.
Ms. Bedell: Young people should use the debit if they are having trouble controlling their spending and need help staying on budget. If the money is not available in their account, it is not possible to spend it, unlike the high credit limits offered by credit card lenders.
Mr. Klingelhoeffer: For things like rent and utilities, it’s probably best if these payments are debited directly from your bank account. This way, you pay your bills before any discretionary spending. For many people, when we see a higher balance in our bank account, we are likely to spend more, even if those dollars are reserved for bills. If you squeeze out those payments first, it’s a little easier to know what you can spend and resist the temptation to spend more than you otherwise would.
WSJ: Are there any downsides to young people using debit cards?
Ms. Bedell: No credit history, little or no cash back, and higher user liability for theft and fraudulent use of their card. For debit cards, it’s also a good idea to set up alerts so you know your balance before that fancy dinner date. Likewise, alerts on your checking account, such as low balance notifications or high transaction notifications, can help you stay on top of potential cash flow issues. Also, be sure to check your statements diligently or set up security alerts for all debit transactions.
Mr. Klingelhoeffer: If you only use debit, you won’t create a good, stable history of responsible credit usage. This could be a problem when it comes to buying a home or other major purchase. No credit history means much higher rates on those items that almost everyone has to finance.
WSJ: What are the main misconceptions young people have about using speed?
Ms. Bedell: In my experience, the concern is that the debit is less “secure” from a fraud standpoint. This is true to the extent that your liability for fraudulent transactions is higher. However, with so many security features that banks offer to verify transactions, it can be easy to use debit in a way that prevents this from happening. Likewise, users will need to be more diligent in checking their available balance, but again, many banks offer simple, mobile-app ways of doing this, and this offers the advantage of tracking spending much better than credit card.
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Mr. Klingelhoeffer: Most people think that if they use a debit card, they will never have a problem because they can only spend what is in their bank account. But life is unpredictable. Some months we have very good fortune and a larger balance in our checking accounts. The other months, our car’s air conditioning dies and we have to fix it. In the end, cash out doesn’t always equal cash out, so having a back-up line of credit or other temporary source of liquidity is almost always a good financial decision.
WSJ: Do you subscribe to the anti-credit theory for young people and, if not, how accurately should young people use credit?
Mrs. Jackson: There are so many setbacks that people can face with a low credit score and a bad credit history. Although more millennials are getting married and starting families later than previous generations, they still have many traditional financial goals like owning their own home, and many of them are incredibly enterprising. This can be a major hurdle if you don’t have the necessary creditworthiness to get a loan. You could find yourself paying hundreds or even thousands more in interest than you might otherwise have.
Mr. Klingelhoeffer: Young people should use credit for almost anything they buy. Setting up a system for spending reliably on credit and then paying your bill at the end of each month is a great way to develop good money habits. If overspending is a problem, there is nothing wrong with asking your bank for a lower limit; they will almost always say yes.
Ms. Bedell: Credit doesn’t have to be the enemy, as long as you know how to use it responsibly. Young people should use credit primarily to build a credit history, ideally a good credit history, by paying off the card with each statement.
Where to start
WSJ: How should young people start building credit and good credit practices?
Mrs. Jackson: I recommend not using credit cards beyond what you can afford to pay monthly, so if someone gets their first card they can try setting it up for a few small bills (cell phone, utilities etc.) and make sure auto-pay is turned on so they never pay late or incur interest. Another option for young adults is to be added as an authorized user to their parents’ credit card account. This can create open communication about best practices within the family and provide ongoing monitoring and guidance as the child learns.
Ms. Bedell: Store credit cards, such as Macy’s, Target, etc., are generally more forgiving when faced with a lack of income or a credit history, and often approve a new user for a small amount to start. This can be the cornerstone of your credit history, before you apply for a credit card with more inclusive benefits.
WSJ: What’s the biggest misconception young people have about using credit?
Ms. Bedell: In my experience, the biggest misconception is that users don’t need to stick to their budget if they have a credit card. It can be easy to make big purchases with a credit card, forgetting that one day that bill will have to be paid. This concept is exemplified by millennial David Rose on the sitcom “Schitt’s Creek” when he fails to realize that the expensive eye cream he received from France will eventually come back to haunt him on his credit card bill.
Mr. Klingelhoeffer: The biggest misconception is that you have to spend a lot or focus on “building credit”. Building credit takes time. Banks want to know that you are a good risk to have on their books for many years to come. If you just put your discretionary purchases on a card for a number of years and still pay your entire bill, you’ll have wonderful credit much faster than you imagine.
Ms. Winokur Munk is a writer in West Orange, NJ. She can be contacted at [email protected]
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