How can financial illiteracy harm you?

The American Dream may be to become a billionaire, but with poor financial literacy, this dream is probably next to impossible. Ironically, it is easier than ever to become rich these days – but only with the right knowledge about finances. Simply put, we have to spend less than we earn, but this is easier said than done.

While people in the past only dealt in goods and cash, we are faced with a multitude of financial options these days, from insurance to investments to credit. These can make our lives much more convenient, but they can also hinder our financial progress if we use them incorrectly.

Overspending

With cash, we spend only what we have on hand – anything more than that amount, and we simply do not have the money to pay for it. However, with credit cards, people are no longer limited by the amount of money they have. Credit cards are a powerful tool when used correctly, as they offer a short-term loan with no interest as long as the bills are paid in full by the end of the month. On the other hand, since credit cards do not deduct money directly from the person’s account, this allows people to bite off more than they can chew – spending more than they even have in the bank.

Credit card companies are also notorious for their high interest rates on any outstanding amount that carries over from previous months, easily racking up if the person leaves the bills unpaid. Most companies also make the monthly minimum payment a very small amount so that their customers can afford to pay. However, paying only the minimum amount and allowing the rest to carry over to the next month begins a slippery slope where you may spend the next years or decades repaying the loan – and inevitably end up spending more on the interest than your original purchase. It is easy to fill out a form and receive a card with “free money”, but one must consider that they will have to repay every cent they spend, including interest.

Even if we have the money to pay for our purchases, it is also dangerously easy to fall into the trap of feeling as if we are not paying anything. With Internet banking, we have access to the funds in our bank accounts 24 hours a day. Swiping a debit card or making a purchase online takes only a few seconds, but without actually handing over cash or a check, it could be almost as if we are not spending money at all, especially if the amount is small. Many people run into the issue where these small amounts all add up and they realize they have spent more than intended.

Poor Credit Rating and Debt

Credit rating or credit score is the measure of how likely a person is to pay back their debts. It is affected by a number of factors, including current personal income, any outstanding loans and how well the person was able to repay any previous debts. Generally, a person who still owes a lot of money after their expected repayment window will have a poor credit rating. Failure to understand the meaning of credit, as happens often in financial illiteracy, can eventually harm your financial life and severely limit your opportunities.

Of course, money lenders are only willing to lend money if they can be sure they will be getting it back. With a credit score of 620 and below, a person tends to be considered a credit risk and may be rejected by some financial institutions. With a poor credit rating, it can be difficult to take out a loan, apply for a credit card, buy a house and more.

However, those with a low credit score are usually the ones in greatest need of financial aid. If they are unable to get a loan from a financial institution, they may resort to approaching unlicensed money lenders, who tend not to care about credit rating because they have other methods to extricate their money back. Unlicensed money lenders may appeal to people who are tight on cash as they typically lend large amounts of money without caring too much about a borrower’s financial history. However, unlicensed money lenders also charge exorbitant interest rates, usually making the financial situation worse for the borrower. If a borrower is unable to repay the principal amount and interest, the unlicensed money lender may employ measures such as gangs, harassment and violence to enforce repayment.

Borrowing money and debt goes in a vicious cycle because the ones who would borrow from unlicensed lenders are also more likely to have poor financial literacy. Without planning their funds carefully, they may find their loan quickly gone and themselves in deeper waters considering that they have to repay the interest as well. Some people may take on a second loan to repay their first, which could solve the problem temporarily but pushes them even deeper into the mess in the long run.

Retiring in Poverty

Currently, 15 percent of the American population is older than 65. This number is expected to go up to 25 percent in 2050. The average expected lifespan is increasing, but this also means we will need more money for our retirement. Additionally, the age of retirement is also rising. While one could comfortably retire at perhaps sixty in the past, we see the elderly working way past that age these days, up till their seventies or even eighties. With the increased costs of living in most major cities, financial planning has never been so important.

Since 1991, the number of bankrupt retired Americans has increased by five times. An eighth of the 800,000 bankruptcy claims filed each year are from households headed by an elderly person. Apart from taking into account the rising expenditures and longer lifespans, we also have to consider the likelihood that we will retire without a pension or government grants in the future. Numerous countries are slowly reducing the financial aid given to the elderly, requiring them to pay more of their living costs out of pocket. The elderly are also particularly susceptible to healthcare issues, which can put a hole in their funds without the proper coverage. In fact, retirees are now spending 20 percent of their income on healthcare bills, even when they are covered by Medicare. This figure has risen from 12 percent in previous generations.

When we are in our twenties or thirties, retirement may seem like a long way away. However, we should make the most of our younger years while we still can and plan our finances well. It is never too late to start saving up for the future, allowing us to be able to look back at our earlier years without any regrets. 

Author: Kelly Felder