Focus on Credit Cards in College
Building and maintaining good credit are two important parts of achieving financial independence. But credit cards also carry risks, especially for students who are just learning the basics of financial responsibility. Before you sign up for your first credit card, it’s important to gain a clear understanding of the credit rating system and how credit spending can impact your immediate and future financial outlook.
The good news is that most college students are actually using credit cards responsibly. But credit card use does carry certain risks. It’s important that you choose a good credit card offer, that you manage payments effectively, and that you understand the implications of your credit rating. It is a good idea to have a credit card at your fingertips in college. It can come in handy in the event of an emergency, you can earn cash-back with smart purchasing decisions and, most importantly, you can begin building a good credit history before graduation. Just be sure you understand the short- and long-term implications of credit cards.
How Do Credit Cards Work?
The first step, even before you review credit card offers, is to understand how credit cards work. Credit cards provide you with a line of credit which can be used to make purchases or receive cash advances. You are required to repay this balance over time. Most credit offers require you to make at least a minimum monthly payment by a specified due date. In most cases, this minimum payment includes a portion of your balance and interest on this sum.
There are a few key figures you should understand before you consider credit offers:
- Annual Percentage Rate (APR): This is the annual interest rate on your total balance. Many credit card offers include two different APRs: one for purchases; and one for cash advances. The cash advance APR is typically slightly higher. The APR is used to derive your monthly interest charge, which is 1/12 this sum. So if you have an APR of 22.9%, you’re paying 1.9% interest on your total balance each month, in addition to your installment on your overall balance.
- Monthly Interest Charge: Based on the figures above, if you have a total balance of $2300 with a 22.9% APR, you would calculate your monthly interest payment as follows:
- Credit Limit: Your credit limit is a predetermined limit on how much you can borrow for purchases. This spending limit concerns your total balance due, which means your spending ceiling includes both your principal balance and any interest accrued. If you are a long-term customer with a good credit rating and consistent payment history, you may request, or may even automatically receive, a higher credit limit. While this can give you more spending flexibility, it does come with the added risk of accumulating higher credit debt. Carrying a high balance for any extended period of time will ultimately cost you money in interest payments.
- Cash Advance Limit: Many credit offers also allow you to take out cash advances. There is also a limit to how much cash you can borrow, and this limit is typically lower than your purchase limit.
$2300 * .229 = 43.7.
This means you’ll be paying roughly $43.70 per month in interest, in addition to paying an installment on your overall balance. The APR is the most critical number to understand when evaluating credit offers. This is the annual cost of borrowing money against your credit line. So naturally, this means, the lower the APR, the better.
Understand Your Credit Rating
Understanding credit offers is one thing. Being approved for these offers is another thing entirely. Any time you apply for a credit card, this action will prompt a credit inquiry into your spending and repayment history. This inquiry yields a report that indicates whether or not you have any bad debts, a history of late payments, or any outstanding actions with debt collectors. The report ultimately produces a three-digit figure called a credit rating or credit score.
Your credit rating is a numerical representation of the potential risk you may pose to prospective debtors or lenders. This score tells individuals, businesses and government agencies what your likelihood is of paying your credit card bills.
Your credit score is measured on a scale of 300 to 850. The higher your score, the better your credit, and the more likely you are to receive credit cards with favorable terms like low APR, higher spending limits, and more rewards. The lower your score, the likelier you are to be rejected for credit cards and loans, or to be saddled with higher interest rates and credit cards with lower spending ceilings.
Though credit scoring models may vary, the standard credit score breakdown looks like this:
- Poor: 300-629
- Fair: 630-689
- Good: 690-719
- Excellent: 720-850
In addition to the role your credit score plays in accessing credit card offers, using your new card will have direct implications to your credit rating. This is why effective credit card management and responsible spending are so important. Bad credit could stand in the way of your ability to lease a car, buy a house, or receive a small business loan in the future. Your prospective employers may even choose to pull your credit report as part of your background screening.
Your credit score could also directly impact your ability to refinance student loans. Lenders view your credit score as a determinant of your ability to repay your debt, and will use this figure to calculate the risk of taking on your loans. If you are viewed as a high risk, lenders will either be unwilling to take on your loans, or will only do so at a higher interest rate. In the latter case, this interest rate might ultimately overshadow any benefits from refinancing.
This all underscores both the value of responsible credit spending in college and the danger of irresponsible credit card use.
Know What Can Hurt Your Credit Rating
Your credit rating will have a direct impact on your access to immediate credit lending opportunities as well as your long-term spending flexibility. The best way to begin cultivating a good-to-excellent credit score is to start with a credit card in college. But in order for this to be an effective strategy, you should know exactly what not to do! There are many different actions that can negatively impact your credit rating, including:
- Making late payments
- Paying only the monthly minimum (or less)
- Missing several payments
- Having debts referred to collection agencies
- Carrying too many high balances
- Maxing out multiple credit cards
- Canceling credit cards
- Applying for and carrying too many credit cards
- Entering debt management, debt consolidation, and loan refinance programs*
- Foreclosures, Bankruptcies, Short Sales, and other Estate programs
* Debt consolidation and loan refinance programs typically provide “hard credit inquiries,” which can result in small credit downgrades. But in most instances, a beneficial consolidation or refinance program will provide greater long-term benefits through reduced interest and credit improvement. For more, take a look at our Focus on Student Loan Refinancing.
Negative credit habits can result in late fees, higher penalty-based interest rates, and in chronic cases of nonpayment, referral to a collection agency. These events will result in a lower overall credit score, which will make you less eligible for favorable credit offers and may even prevent you from making major future purchases like a car lease or home mortgage.
The very best strategy for improving your credit and avoiding excess interest is to pay off your balance in full every month.
College is a Great Time to Start Building Credit
While there are a lot of risk factors that can damage your credit rating, it’s important to begin building a meaningful credit history. Lenders are looking for evidence that you are capable of effectively managing credit debt before allowing you to rent apartments, lease cars, or receive mortgages. Start building your credit in college, but do so wisely and within your limits.
A 2016 study from Sallie Mae reports that 56% of college students had their own credit card. 60% of those borrowers used their first credit cards as a way to build good credit. According to CNBC “About 60% of students say they pay off their credit cards in full every month and fewer than 1% say they pay less than the minimum, according to the report.”
If you can exercise this same level of discipline, seeking out a good credit offer could significantly improve your financial standing as you prepare for graduation.
Are there credit cards specifically made for college students?
One of the challenges that college students face when applying for credit cards is an absence of credit history. There are some credit cards that are designed to help students start establishing this credit history:
Most major credit card companies provide at least one offer which is specifically designed for students. Look for a reputable company—like Mastercard or Discover—and seek out “Student” or “EDU” offers. The best offers will typically provide an easier path to access for students without a credit history. Some student plans also make it easier for international students to be approved for credit. Ideally, a student card will offer a modest APR as well as reward points, or cash back, on common student purchases like meals, groceries and gas.
Another option for students, the secured card is designed to produce good credit spending habits while also placing restraints on spending. The secured card requires the applicant to make an initial deposit. This deposit determines your starting credit line.
However, it is noteworthy that many secured credit card offers do include a bonus credit line with your first deposit. For instance, Nerdwallet points out that qualifying applicants for the Capital One Secured Mastercard may be able to deposit between $49 and $99 in order to receive a $200 credit line.
In addition to your deposit, you’ll still have to make monthly payments on any purchases you make with your secured deposit. However, making timely payments above the minimum amount due will help you establish a positive credit history. With some offers, making a specific number of consecutive payments may qualify you for a higher credit line without an additional deposit. Successful management of your secured card will ultimately qualify you to transition to a favorable offer with a traditional credit card.
Getting a Credit Card Will Help You Establish Financial Independence
Students who are considered financially independent may qualify for more student aid opportunities than students who are considered dependents of their parents or guardians. As a younger earner with a shorter credit history, you may qualify for certain need-based financial aid packages that might not be available under the terms of your parents’ more robust financial outlook. But in order to do this, you must take certain steps to qualify as financially independent.
Building a personal credit history is an important part of achieving financial independence. According to FastWeb, one way to effectively declare independent status on your FAFSA is to “Be a student for whom a financial aid administrator makes a documented determination of independence by reason of other unusual circumstances.”
Certain individuals may automatically qualify as independent, including orphans, veterans and active duty service members, graduate or professional students, married individuals, and those with legal dependents, as well as emancipated minors and homeless youths. If you do not fall into one of these categories, building meaningful credit and using this credit to procure an independent living situation could also help you make your case as a financial independent. If you do so effectively, you would be more likely to qualify for a need-based loan, which is a sum that you won’t have to repay upon graduation.To learn more, check out our Focus on Federal Grants for College.
Beware of Predatory Credit Card Offers
While college is a great time to build credit, it’s also important to exercise caution. Historically, predatory lenders have targeted college students with credit cards that feature both high spending limits and high APRs. Other offers might promise 0% interest for several months before introducing a significantly inflated interest rate. Many of these offers are designed to induce students to spend freely without consideration of the long-term expenses that will ultimately accrue as they make small monthly payments on large balances. More than 60% of college students will already graduate with some form of student loan debt. High credit card debt can compound this financial burden.
According to The Balance “When you’re ready for a credit card, don’t sign up for the first one that comes your way. Instead, comparison shop the way you would for a new car. Look at a few different credit cards and pick out the one that’s the best deal. At a minimum, your credit card should have no annual fee and a low-interest rate. Tables and booths on and near campus are just one-way credit card companies try to get to students. Now, they’ve started emailing students and soliciting credit card sign-ups on Facebook.”
Read credit offers carefully before committing. Know exactly what you’re getting into!
Pay Your Bills On Time!
The most important rule for a new credit card user is to spend only what you can afford to pay back on time. Paying your balance in full, every month, is a great way to build strong credit quickly. If you can afford to pay your balance in full, do it. If you can’t, just be sure that you never miss a monthly payment.
You should also do your best to pay more than the minimum amount each month. Paying only the minimum can reflect negatively on your credit rating, or at least it will prevent you from building better credit quickly. But most importantly, mark your calendar and pay your bill on time, every single month!***
Of course, financial hardship, unpredictable expenses, and other challenges can offset even the best laid plans. The good news is that you can improve your credit over time and you can even repair your mistakes by sustaining sound, responsible credit spending practices. Don’t be discouraged when you run into setbacks. Stay the course and make sound decisions.
If you do everything right while you’re in college, you should also have strong enough credit to refinance your student loans upon graduation.
This is a good option for students who are carrying multiple federal and private student loans, but refinancing may only be available to graduates with strong credit ratings. Now that you know how to build and boost your credit, check out our Focus on Refinancing Your Student Loans.