When Mike Sullivan was getting ready to send each of his three children to college, he added one item to the school shopping list: their very first credit card.
“I wanted my children to have the security and comfort of knowing that they had a credit card in the case of an emergency,” says Sullivan, director of education at nonprofit credit and debt counseling agency Take Charge America.
He also knew the payment method would help each student build a credit file.
“Helping young people understand how you establish credit is very, very important,” Sullivan says. A solid credit score will help them obtain financing and other services, such as a cellphone contract, after graduation. It will also entitle them to better rates, terms and conditions on home, auto and other loans.
Of course, while a credit card can be a comfort, “it is also a risk,” Sullivan says. Poor use and a lack of discipline can lead to big financial woes. It can also tank your child’s credit score before he or she even nets the diploma.
Here’s everything you need to know if you’re looking to get your student a credit card before they head off to college.
The law of the land
The Credit Card Accountability, Responsibility and Disclosure Act of 2009, or CARD Act, prohibits financial institutions from offering a credit card to anyone under 21 unless they can demonstrate their ability to make payments or have a willing co-signer.
It also prohibits issuers from sending this group preapproved credit offers and restricts on- or near-campus marketing. (So, no, you don’t have to worry about your freshman inadvertently signing up for a credit card to get a free T-shirt as soon as they move into their dorm room.)
The law certainly made a dent in the number of student credit card holders. A December 2013 study on the CARD Act conducted by the Consumer Financial Protection Bureau found that only 14.4 percent of consumers ages 18 to 20 had opened a credit card account in 2012, compared with 33.6 percent in 2007. (The report does attribute some of this drop-off to the recession.)
Still, there are several ways you can help your student obtain a credit card, if so inclined.
The basic options
The CARD Act, for starters, does permit co-signing. This approach, however, can be risky since both parties will be held liable for any debt incurred on the card. Also, any negative information associated with the account will appear on your credit report and your child’s.
“If you’re co-signing for a loan, you need to assume you are going to be paying off that loan,” Sullivan says. “You need to access that account regularly … so it doesn’t also destroy your credit.”
Some major issuers have moved away from allowing co-signers to preclude confusion over who’s responsible for the bills. Many, however, will allow a parent to add their child as an authorized user.
“If you have no credit file whatsoever, the best way, we think, to get a credit card is to become an authorized user on a family member’s account,” says Linda Sherry, director of national priorities at Consumer Action.
This option allows you to monitor your child’s spending activity. You can also easily kick them off the account, should they abuse their credit card privileges. Plus, authorized users aren’t liable for paying off purchases. They should, however, receive credit for the positive information associated with the account, such as a stellar payment history.
Just make sure your issuer reports its authorized users to the credit bureaus. If they’re not doing so, “it’s like the tree falling in the woods,” says John Ulzheimer, president of consumer education at Credit Sesame. ” You’re not doing anything to build your credit.”
Keep in mind, too, that many major issuers offer traditional credit cards targeted specifically to students. These cards may be a good option for someone who has a part-time or summer job, since they’ll need to provide proof of income to qualify. They won’t, however, need a robust credit file.
Banks “want to develop a relationship” with younger demographics, says Nessa Feddis, senior vice president of consumer protection and payments at the American Bankers Association. As such, they’ll take a chance on a young applicant, particularly if their parent has an existing relationship with the institution.
Student credit cards “might have a slightly higher interest rate because of the risk” associated with lending to someone who has yet to demonstrate creditworthiness, Sherry says. “But they’re more geared toward the needs of the student population.”
Some of these products, for instance, feature free credit monitoring, financial planning tools and rewards for good behavior, such as paying your bills on time. Almost all of them carry a relatively low credit limit (think hundreds of dollars as opposed to thousands).
“You’re not going to find yourself getting into $20,000 of credit card debt with a student card,” Ulzheimer says. “You have a little bit of credit card debt insurance.”
Still, be sure to shop around for the best rates, terms and conditions.
The secured card
If your child can’t satisfy the underwriting requirements for a traditional card, they may be able to qualify (also, pending proof of income) for a secured credit card.
Secured credit cards require cardholders to put down a cash deposit to cover the line of credit. They’re essentially reserved for consumers who are trying to build or repair credit so your child’s thin or nonexistent credit file shouldn’t be a barrier to entry.
Here, too, you’ll want to shop around for good terms and conditions. Check that your student’s card use is going to be reported to the major credit bureaus, as some issuers may not be in the habit of doing so.
“The same warnings apply,” Sherry says.
And under the Truth in Lending Act, credit card users, even those holding a student credit card, have no time limit to report a lost or stolen credit card to limit personal liability. Debit card users have only two days.
Having a credit card or a student credit card helps build credit history, which is important to your student’s financial success.
“Your child should prepare for after graduation, too,” says Martinez. “He or she may apply for an apartment or want to get an auto loan. These are reasons to build a good credit history.”
Pitfalls of student credit
Because most students have little to no credit history, one small slip-up can cause major damage. Paperno says consumers with “thin” files will hurt their credit score more if they are 30 days past due on a credit card payment versus someone with a robust credit history.
A credit education
Whatever route you choose, it’s important to maintain an active role in your student’s financial education and continually coach them on proper card use.
“This is almost like driver’s ed,” Ulzheimer says. “No parent in their right mind would toss their kid the keys to the car and say ‘have fun.'”
Since your child’s credit file is limited, mistakes can be particularly detrimental. Before forking over a credit card, talk to your child about the importance of paying off balances on time. A first missed payment can cause a credit score to plummet 70 to 90 points, depending on where it’s at when the missed payment occurs.
You also may want to talk to them about keeping the card’s credit utilization — how much debt they carry versus how much credit is extended to them — below 20 percent, since this is another big component of credit scoring.
Make sure to review other big credit report bruises, such as defaults, collections, judgments and liens.
“In the world of credit reporting, getting it wrong is a seven-year penalty,” Ulzheimer says, since most negative information takes that long to age off of your credit file. “As a parent, you have to teach your kids how (credit cards) work or really you’re setting them up to fail.”
Of course, if you feel your child isn’t ready for a credit card, you could open or add an account in their name and then hold on to the payment method.
Just the fact that that the card “exists will create a credit file,” Sherry says. “In some cases, the needs of students can be handled with either a prepaid or a debit card.”
Don’t forget to mind credit limits. A student’s credit limit is probably low, so while charging $175 on a credit card doesn’t seem like much, it will be bad for your student’s credit score if the limit is only $200.
Still, it’s not a catastrophe if your student isn’t squeaky clean. A consumer can recover rather quickly from a misstep like a missed payment or a maxed-out card, says Paperno.
“Definitely within a couple of years you can recover any points lost for a late payment or two,” he says. “Sometimes, sooner than that.”