Who Needs a Credit Card?

What young adults and parents need to know about credit cards and building credit.

“Free credit!” “Come sign up for a credit card and we will give you a free t-shirt!” “Free money!”

Many of you may remember hearing these words as you walked to a football game on your college campus. Or perhaps you remember your college mailbox filled with credit card applications. For those of you too young to remember snail mail, perhaps emailed credit card offers filled your inboxes. Most of these offers of “free money” seemed too good to be true. And they were. Some of us learned the hard way by spending too much and ending up with a load of debt. Some of us were lucky enough to learn from our friends’ mistakes.

Free credit (Aggressive card marketing?) came to a screeching halt for individuals under the age of 21 when Congress passed the CARD Act of 2009. This Act prohibits credit card issuers from offering their products on college campuses or exchanging gifts for completed credit card applications. Many parents applauded these changes. In addition to limiting what the credit card industry could do, the Act also makes it harder for students to qualify by requiring those under the age of 21 to demonstrate the means to repay a debt before they can open a credit card account. This change frustrated many parents trying to help their children build credit. While the changes protected their children from going into debt, they made it exceedingly difficult for them to establish and build their credit scores.

Why is this a big deal? Building credit is very important. Your credit score impacts many aspects of your life. For example, your landlord will pull your credit report to determine if you are a good credit risk—will you pay your rent, and will it be on time? Utility companies commonly check your credit history before providing their services. If your credit history is bad or nonexistent, they may require you to pay a deposit or have a parent co-sign. Employers may pull your credit report to determine if you are at risk for needing money, especially if you will be handling other people’s money. Mortgage and car lenders will use your credit report to determine what interest rate to offer you on a loan. Your credit history, detailed in your credit report and summarized by credit scores, shows how well you’ve handled borrowed money.

Your Credit Score

The three major credit bureaus, TransUnion, Equifax, and Experian, use a “secret sauce” to calculate your FICO credit score. FICO stands for Fair Isaac Corp., which introduced this scoring system in 1989. VantageScore is a new scoring system developed jointly by the three major credit bureaus in 2006. VantageScores track similarly to FICO scores because both weigh the same factors and use the same data from the credit bureaus. Experts agree that the formula used in determining these scores is approximately the following:

• Payment history (35% of your score): Pay your bills on time. Delinquent payments and accounts in collection or bankruptcy hurt your score. Paying on time demonstrates that you are worth the risk when creditors consider extending you credit. Paying down student loans can help you establish credit. However, we don’t suggest you pay student loans down while in college if the loan does not require payments. 
• Amount of debt relative to credit limits (30%): Use approximately 30% of your available credit. Limiting how much credit you use demonstrates that you have control over your spending. You are not overextended and at a higher risk of defaulting.
• Age of credit (15%): This refers to how long you’ve had credit and the average age of your accounts. Again, this shows you are in control of your spending. You wisely use your credit over prolonged periods of time.
• Recent applications for credit (10%): A “hard inquiry” when you apply for new credit can negatively impact your credit score for up to six months. Research offers and eligibility requirements before applying for a credit card or other loans.
• Types of credit (10%): There are two primary types of credit. Installment loans, like car loans or mortgages, have level payments. Revolving credit is a line of credit against which you can borrow, like a home equity line of credit (HELOC) or credit card. Utilizing both types of credit can help your score.

What is a good credit score? Most lending institutions agree that a score of 700 or higher represents a good credit score. Credit scores range from 300-850. According to Credit Karma, the average score for those in the 18–24 age range is 630. Anything above 630 is considered an above-average credit score for a college student.

Your Credit History

The keys to building your credit history are using a credit card responsibly, paying your bills on time, utilizing as little of your credit as possible, and paying the balance in full each month. These habits will contribute to a good credit score and could help you graduate to a traditional credit card later.

A debit card from a bank or credit union is not a credit card. Debit cards, while convenient, do not report your transactions to the credit bureaus because no credit or lending of money is involved. Peer-to-peer (P2P) payments such as PayPal and Venmo also do not extend credit and do not impact your credit history unless you link the payment to your credit card.

Getting Started

As a college student, you may have little or no credit history, which, paradoxically, makes it hard to qualify for the financial products that can help you develop a credit file. So what can you do? The best solution is to find a student credit card. A student credit card is designed for and marketed toward students and recent graduates. Student credit cards are helpful first credit cards, particularly for building credit. They generally have lower credit limits than traditional cards, which means their income requirements may be less stringent.

Research the best student credit cards currently available. Each year, many websites, including Bankrate and NerdWallet, research and rank student credit cards. You should know if you qualify before you apply for a card. Make sure you meet the card issuer’s general requirements. Typical requirements are:

• Have a social security number.
• Be at least 18 years old.
• Be enrolled in college. Some credit card companies will require proof to confirm your enrollment.
• Earn an income. Credit card providers look at your income to determine your ability to pay and to arrive at a suitable credit line. Consider all forms of income – part-time jobs, paid internships, freelance work, college work-study programs. Financial aid, student loans, and scholarships may count as income after the bills for which they were given have been paid.

If you do not qualify for a student credit card.

• Consider asking a family member to co-sign. The idea is that you have an account in your name, but should you be unable to make a payment, your co-signer will be responsible for that payment. Missed payments will affect both you and your co-signer’s credit scores.
• Wait until you are 21. At age 21, you can list the income of all individuals in your household, provided you have access to these funds. Do not abuse this power and list income not available to you. The key to remember is that you are still on the hook for paying off the expenses charged on the card.
• Become an authorized user on another person’s credit card. This strategy will only build your credit if the issuing creditor reports authorized users to the credit bureaus. Confirm this reporting before using this method.

Review your credit report regularly. The three major credit bureaus allow you to check your credit for free once a year. We suggest you ask for a report from a different bureau every four months. To get your free report, go to annualcreditreport.com or call 1‑877‑322‑8228. Please note that this is the only legitimate source for the free credit reports. Review your report for inaccuracies. If you find inaccuracies, work with the bureaus to correct the information. Take steps to improve your credit score.

There are a few things to look at as you compare the cards for which you qualify.

• Credit reporting – Does the card report to all three credit bureaus? If not, look for a different card.
• Type of credit card – Does it offer cash back, points or miles? Does one card offer more rewards in the areas you spend the most? Student cards may NOT provide these benefits. Just remember your primary goal with this card is to build up your credit score, not your points.
• APR (interest rate) – We encourage you to pay off the balance in full each month. However, due to unforeseen circumstances, you may find you cannot pay off the entire balance one month. The lower the APR, the better.
• Additional fees – Does the card have annual fees, foreign transaction fees, or monthly maintenance fees? Fewer fees save you money.
• Introductory offer – Make sure you understand all the details. For example, do you need to spend a certain amount to get the offer? Will the APR jump after a certain amount of time? Will there be additional fees beyond the introductory period?
• Security features – Look for cards that offer fraud protection or overdraft protection.

Gather the necessary documents and apply for a card. The easiest way is to apply online. However, if you are concerned about your ability to qualify, you may want to call and speak with a representative prior to applying. When applying, you will need:

• Your social security number
• Your monthly housing payment
• Your contact information
• Details of all your income, including deposits into a shared account
• If you have a co-signer, you will need their financial and personal information too.

If you are denied a credit card, a likely reason is that you don’t have sufficient credit history. You can confirm this by asking the issuer for an adverse action letter, which explains why the company declined to extend you credit. Remember, there is a “hard credit inquiry” each time you apply for a card. Multiple hard credit inquiries over a brief period of time will negatively impact your credit score.

If you cannot qualify for a student or traditional credit card, you may want to consider a secured credit card. These cards are designed to help individuals with little to no credit. Secured credit cards require a cash deposit that becomes your credit limit. Minimum deposit requirements tend to be $200 to $300, but some can be as high as $500. Pulling together the deposit on a student income can be a challenge, so you may have to save up or ask someone to help out. You get your deposit back when you close your account in good standing or upgrade to a “regular” credit card with the same issuer.

Make the most of your card

Lay a sound foundation for good credit habits early and enjoy some rewards from having good credit. Remember the keys to building credit and creating good spending habits.

• Buy only what you can afford. Before making a purchase, ensure you already have or will have the money to pay the balance in full at the end of the statement date.
• Pay your full statement amount before the due date each month to avoid being charged interest. If you can’t pay your entire balance, pay at least the minimum and more than the minimum if you can.
• Use your card as a tool for building good credit, not for spending money you don’t have. Use it for small purchases you would make anyway, not for indulgences you wouldn’t buy if you were paying cash. You’ll maintain control of your budget and save money on interest.
• Use only a portion of your available credit. (30%)
• Be strategic about sign-up bonuses and rewards. If your student credit card offers a sign-up bonus, timing your application around upcoming expenses can help you meet the bonus requirements without additional spending. Choosing a credit card with rewards that match your spending will also prove more fruitful for your wallet.
• Keep your account open if possible. Inquire with the card issuer if you can upgrade from a student card while keeping the same account. If your credit card doesn’t charge an annual fee, consider keeping it open, even if you put it in a drawer and don’t use it.

We cannot emphasize enough the importance of paying your balance in full each month. If you pay in full by the payment due date, there is zero interest charge. If you pay late or less than the full amount, you will be charged interest on your outstanding balance. Interest is calculated daily. If you are unable to pay the full amount by the statement date, try to pay it as soon as possible to avoid daily interest charges. You do not have to wait until the next payment date to make a payment. Interest will continue to accrue on unpaid balances—including interest already charged—until the amount is paid in full.

Used foolishly, a credit card can spell financial disaster. Many people spend decades digging out of the hole of debt they began to accumulate in their college years. Used wisely, however, a credit card can help create a solid track record of financial responsibility. It can be a tool to track and manage spending. It can give you an advantage when it’s time to borrow money for a vehicle or house. Do your research, know the risks, and you, too, can turn a credit card into a tool that works for you instead of a weapon of your own financial destruction.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.