It’s a question our younger clients ask regularly, and it’s one I have received recently from my children. The quick and easy answer might be, “Yes, of course you must obtain a credit card to build your credit!”. And, while establishing credit is a chapter firmly entrenched in the book of surviving consumerism, financial counselors and other professionals who provide financial education, must delineate the risks, as well as the rewards, of starting down the plastic-paved road. Our failure to help our clients illuminate the hazards of abusing debt could impair their ability to successfully achieve their financial goals. Worse yet, poor credit management may ultimately lead to dire life challenges, including insufficient food on the table or the inability to pay for a critical car repair.
With such potentially adverse outcomes on the line, a thorough exploration and analysis are necessary to determine the rewards and risks associated with obtaining a credit account.
Conducting a thorough conversation
This type of dialogue between counselor and client is similar to a risk tolerance questionnaire, which attempts to determine an investor’s stomach for gyrations of “the market.” Likewise, when we are asked if establishing credit is appropriate for a client, we must help the individual see that the temptation to spend without the ability to repay—the risky side of credit—may jeopardize the client’s plan or even their financial health. To do this, we may provide examples, real or hypothetical, about the caustic effects that debt payments have upon cash flow, net worth and the ability to obtain wants or needs. An easy yet powerful dialogue with a client might go as follows:
Imagine that you have received a credit card with a reasonable credit limit. Although you intend to pay the card off in full, an unplanned expense soon occurs and you cannot repay the entire balance. A series of such unfortunate circumstances, or unbudgeted events like the holidays, eventually leads to a maxed-out card. This is temporarily alleviated when the credit union/bank raises the credit limit. However, the credit card balance gradually grows. As time progresses, additional credit is repeatedly offered by the current and then by new creditors, resulting in ominous minimum payments and a possible debt spiral.
Here’s how this scenario might look on a dry erase board or on paper:
Perhaps this looks like a simplistic lesson, but we cannot assume—in the best interest of our clients—that the most basic principles are firmly engrained in the people we help. On the contrary, there can never be too much understanding of the forces that [may] erode our clients’ financial dreams.
Exploring the decision to obtain credit doesn’t have to employ scare tactics. Instead, we can review strategies that clients may use to reduce the likelihood of credit abuse while simultaneously enjoying the benefits of establishing credit. Such techniques include maintaining lower credit limits, using a secured credit card, and creating an ample emergency cash reserve to prevent credit use out of necessity.
Some clients prefer avoiding credit altogether
Part of our credit discussion may also focus on a financial life without obtaining credit, since some consumers wish to avoid getting or using credit altogether. The widespread use of credit scores today requires a strategic, thoughtful approach to shunning credit, and financial educators should be prepared to help these clients face the challenges of such a decision. After all, if their goal is to achieve financial success/independence while circumventing the credit arena, we should provide the appropriate guidance they need.
Credit scores are ubiquitous and arguably the most oft-discussed topic among the many facets of personal finance. In fact, striving for impeccable credit can be downright competitive, as people frequently compare their scores or even credit limits to those of their acquaintances. In other words, establishing credit and developing credit scores is a serious business. Considering the challenges and pitfalls associated with building credit, when our clients ask, “Should I get a credit card?” we should avoid the quick answer and conduct a thorough conversation.
How do you respond when clients ask if they should obtain a credit card?
When a client wishes to avoid establishing credit, what recommendations do you give him/her?
Guest Contributor: Dave Kershberg, AFC®
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