When Sara, 21, applied for a bank job, she didn’t realize her credit report would be part of the interview process. (She prefers Next Avenue not include her last name.) But the bank checked the credit histories of potential hires and asked her to explain why hers was so poor.
As a college freshman, Sara had a low-limit ($300) credit card she paid off each month. In the spring, she decided to pay back the card’s $150 balance in the summer, and then skipped making payments for a few months, not realizing she needed to continue sending the card issuer at least the minimum monthly payment for a good credit record. By August, her balance had ballooned to $300, and her credit score was in the tank. The issuer promptly cancelled her card, and now two years later, she’s still rebuilding her credit. She wishes she had understood all the ways that skipping those payments would penalize her.
Sara’s not alone among college students and recent grads in not understanding how to manage credit cards or what credit scores mean. So if you’re the parent of one, you’ll want to explain why establishing good credit is key for a post-grad future of utility bills, auto insurance and apartment rentals (as well as becoming financially independent) — and that wise use of a credit card can be a help.
“Credit cards provide peace of mind for emergency purchases and offer superior fraud protection to debit cards,” says Gerri Detweiler, director of consumer education for Credit.com, a free educational website. They can also jump-start essential conversations about money and debt management.
So pass along the following lowdown on three ways to start out with credit cards and tips for handling them without getting burned:
Making your child an authorized user of your card promotes conversations about spending habits, because you can monitor the card.
— Gerri Detweiler, Credit.com
Becoming an Authorized User
This can be an easy, low-risk way to build credit. You, the parent, add your child as an authorized user to your existing card account if your card allows (most do) and designate a separate, low credit limit for your son or daughter.
Your student benefits from your good credit score because the account’s usage information appears on both the primary and authorized user’s credit report. “This arrangement also promotes conversation about spending habits, because parents can easily monitor the card,” Detweiler says.
Students might qualify for their own card after six months of positive credit history, she adds, but if they’re under 21 they must be employed.
Downsides: If your child doesn’t pay his or her bills, you could get stuck with the cost. Conversely, if you don’t manage credit card debt well, those habits will negatively affect your child’s credit score.
Getting a Secured Credit Card
Typically, a secured card is available to anyone 18 or older and simply requires a small deposit of $500 or $1,000, which serves as the card’s spending limit. The deposit doesn’t pay the monthly bill — the user must make payments — but it secures the user’s credit and limits how much he or she can charge. When the account is closed, the deposit is returned.
“It’s like a credit card on training wheels,” says Laura Adams, a personal finance expert and host of the Money Girl Podcast. “It might be more beneficial than ‘authorized user status’ because it’s in the child’s name.”
Among secured cards, Credit.com recommends the Capital One Secured Mastercard. But you might want to check with your bank or credit card issuer to see if it has a secured card worth considering.
Downside: The low spending limit
Getting a Regular Card in His or Her Name
This offers a powerful way to build credit. If your child has conscientious spending habits and experience handling a debit card or managing an allowance, an individual credit card with a low limit of, say, $500, can be a good idea. One card that Credit.com likes is the Discover It Chrome for Students, issued by Discover.
Downsides: The Credit Card Accountability, Responsibility and Disclosure Act of 2009 (CARD Act) requires people under 21 to show proof of income, at least part-time, to get their own card; students won’t qualify without jobs. Also, if your child lacks the organizational skills to track payments, an individual card could backfire.
6 Tips for Smart Credit Management
- For secured or traditional cards, establish electronic notifications via smartphone apps or email regarding payments due and charges over a certain amount.
- Set up up online card payments to avoid missing a bill in the mail (especially if away at college) and pay the full bill if possible. For forgetful types, consider auto pay for minimum monthly amounts.
- Limit credit purchases to 20 to 30 percent of the card’s credit limit to avoid a high “debt usage” ratio, which compares the limit to the balance. A low debt usage ratio builds a good credit score.
- Shop for cards with no annual fee and a low interest rate rather than a rainbow of rewards.
- Don’t sign up for multiple cards (students can lose track of balances and payment dates).
- Get a free credit report once a year at Annualcreditreport.com to track your credit history. Sites like Credit.com and card issuers such as Citi and Discover can provide free credit scores.