Despite waves of strict legislation, credit card companies still spend millions to attract new, young customers — and many financially inexperienced students are signing up, often to their own detriment.
Gone are the days of credit card booths on campuses and at college events luring students with free T-shirts and pizza.
The Credit CARD Act, which passed in 2009, reeled in much of those practices with laws that restricted card companies from issuing credit to students unless they can demonstrate the ability to make payments or have a co-signer and prohibited pre-approved offers and enticing freebies.
As a result, the number of college-age consumers opening a card fell off dramatically. Only 14.4 percent of consumers age 18 to 20 opened a credit card account in 2012, compared with 33.6 percent in 2007, according to a 2013 study on the CARD Act conducted by the Consumer Financial Protection Bureau. (Last week, the U.S. Department of Education also tightened regulations on debit and prepaid cards, issuing regulations to eliminate “unreasonable fees” and stop “troubling practices” that have been associated with cards marketed to college students.)
These days, in order to get a credit card, college students must either put down a deposit in exchange for a secured card or get a parent or other adult to be a co-signer, which means the co-signer is also on the hook should they fall into credit debt. But there are additional steps students can take to be sure they pick the best card for their needs and start building a good credit history.
“The laws have changed, but students still need to make thoughtful decisions,” noted Stuart Ritter, a certified financial planner and vice president of T. Rowe Price Investment Services. “The seeds they plant today are going to have a big impact on their future.”
Credit cards are still considered the best way to begin a credit history, which is important to young adults just starting out. Good credit paves the way to low interest rates on mortgages and auto loans, and can even make it easier to get an apartment rental.
Alternatives to credit cards, like debit cards linked to a checking account, or prepaid cards, which act as a defense against overdrafts, can help build good habits, but neither contributes a credit history. “A credit card makes sense to establish a credit history — just use it for small purchases you can pay in full,” said Bankrate.com chief financial analyst Greg McBride, “and that goes for whether you are in college or older.”
But Ritter said students often share a common misconception that you need to carry a balance and pay interest to build a credit history. In fact, credit cards are one of the most expensive ways to borrow.
What students borrow compared to the total credit available to them, also known as your debt utilization ratio, counts for a whopping 30 percent of their credit score. So paying off charges quickly and keeping a balance low can help students save on interest and boost their scores.
A debt utilization ratio greater than 30 percent can negatively affect a credit score, anything between 10 percent and 30 percent should have no impact and a utilization ratio below 10 percent can have a positive impact, McBride explained. “Those smaller balances are the ticket.”
Alex Matjanec, co-founder of bank comparison site MyBankTracker, recommends students limit their card use to day-to-day transactions or two to three set expenses a month and set up auto payment through a checking account to protect themselves from missed payments and late fees.
He also suggests that students look beyond their campus bank’s offerings and research and compare the best credit card options online.
Some worthwhile contenders include cards that offer cash back on gas or groceries with no annual fees, although there may be a high APR in return, said Jill Gonzalez, an analyst at credit-card comparison site Cardhub.
Students who intend to travel abroad should pick a card with no foreign transaction fees and those who want to use the card for a few initial big-ticket purchases, such as textbooks or a TV, and carry a balance temporarily are better served with a card that offers a zero interest rate for the first six months or initial bonuses, she said. (Cardhub has compiled a list of its picks of best credit cards for college students.)
Either way, students should find the one card that fits best and limit themselves to no more than three credit cards in all, Gonzalez added. “Find a happy balance.”