A few weeks ago I asked my Facebook friends what they wished they’d been taught about money as kids. The vast majority of responses had to do with wishing they had a better understanding of credit.

We live in a society where we don’t have to wait for anything. We don’t have to save for new furniture, a new gadget, a new vehicle or a nice meal in a great restaurant. We don’t even need to build a contingency fund; money is instantly available to us, regardless of how much we actually have in the bank, as long as we have access to credit.

In the US only 3% of all the money in circulation actually exists in physical form. The other 97% exists solely in computers. Most of our financial transactions aren’t made using real money and yet we can use this mythical currency to buy whatever we want. If it’s managed well then credit can open doors to opportunities that we might never be able to take advantage of but if it is mismanaged then it can sink us into holes far deeper than the ones we could dig by ourselves.

We live in a world where credit cards and credit lines are routinely offered by bank tellers when we visit the branch, pre-approved offers are sent out by credit card companies in the mail and carrying consumer debt is the norm. We live in a society where it’s universally assumed that the only way to build good credit is to use it and that makes our children incredibly vulnerable once they become adults.

When our kids see us paying for everything with plastic but never see us pay the bill with real money how are they supposed to understand that what they’re seeing is an illusion? If we don’t talk to our kids about credit, if we don’t educate them on how compound interest is a fantastic thing when it comes to your investments but a nightmare when it comes to consumer debt, then how are they supposed to make an informed decision about credit?

As human beings we’re hard-wired for pleasure and instant gratification is an immensely pleasurable thing. There’s little hope that our kids will ignore the tempting offers that seem too good to be true unless they understand that they actually are. Here are a few facts about credit that I wish I’d known at 18.

“Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like.” – Will Rogers

Understand How Interest is Calculated

Debt is an amazingly profitable way for retailers and financial institutions to make money. The vast majority of credit products don’t get paid off in full every month and there is a lot of money to be made in compounding the interest charges daily and applying fees for late payment and going over the approved credit limit.

Lots of people who have credit cards don’t know how much interest they’re paying and they don’t realize that the credit card company can increase that rate if you miss payments or don’t make your payments on time. The higher the interest rate, the greater the amount of your minimum payment that is being applied to interest and the smaller the amount that is actually reducing your outstanding debt.

I worked with a client recently whose minimum payment on a store card with a $350 balance was $62/month. Of that $62 only $7 was actually applied to his balance – the other $55 was interest (29.9%APR). He could easily have paid it off in one or two months, he just didn’t realize that by choosing to just pay the minimum he was setting himself up for at least four years of payments and more than $2000 in interest to get it paid off!

Similarly, if you buy something on 18 months interest free store credit and you don’t pay your balance by the due date your interest is backdated to the date you made the purchase, usually at a high rate. Suddenly, your $5000 of furniture is costing you $7500 and it’s accumulating interest daily; not quite the bargain it was when you bought it.

Teach your kids to pay attention to their statements and financing agreements and to be fully aware of how much interest they’re being charged and what the due date of their payments is. If you know what the pitfalls are you’re less likely to fall for them.

Pay Your Card Off in Full Every Month

Make sure that your kids are aware that unless they pay off their card balance in full every month they’ll pay interest on the entire amount that was owing. For example; if they owe $4000 and pay $3999.99 they’ll pay interest on the whole $4000 not just the penny that’s outstanding.

Credit card charges can add up and the cost of the charges always outweighs the “rewards” offered by the card.

Know Your Limit. Stay Within It.

If you make regular payments on your cards chances are the credit card company will arbitrarily decide to raise your credit limit. Kids need to understand that the companies are not doing this to be nice; they’re doing it to tempt them into living beyond their means and carrying a balance they can be charged lots of interest on!

If you don’t have enough money in your contingency fund to pay off your entire credit card balance then your limit is too high and you’re in an incredibly vulnerable situation; one missed pay cheque and you could be in trouble.

Credit card companies are especially generous when it comes to the limits on student credit cards. I have one client who graduated from university with a $23,000 balance on her credit card and she wasn’t the only one among her peers to have a limit that high. It’s been seven years since she graduated and she’s nowhere close to paying it off because the interest is crippling.

Teaching your kids how to handle credit properly helps them recognise situations that don’t benefit them and gives them the understanding needed to call the company and get the limit reduced back to a comfortable amount.

At the end of the day, the more you can rely on your own savings and the less you can use credit the better position you’ll be in. Used properly, credit can be useful but if it’s misunderstood and mismanaged it’s all too easy to fall into a hole that can take a long time to dig out of. Encourage your kids to get educated about credit and to use it wisely.

Encourage your kids to get educated about credit and to use it wisely. Here are a few facts about credit that I wish I’d known as a kid.

About Sarah Milton

Sarah Milton is a Financial Security Advisor, Investment Representative, Writer and Speaker based in Edmonton, Alberta. She is passionate about inspiring people to get excited about their money and empowering them to take control of their financial future. You can follow Sarah on Twitter @5arahMilton