A college student’s guide to establishing credit and using credit cards as a financial tool
By Talia Smith
During my last trip to the bank, my banker checked my account, looked up from her computer monitor with a grin and extended her arm for a fist bump. What did I do to deserve such a first bump? I had a killer credit score.
What is a credit score?
A credit score helps credit card companies determine the risk involved with lending money to an applicant. A score can range anywhere between 300 and 850. A high credit score indicates a low-risk applicant whereas a low score indicates a high-risk applicant. Credit card companies offer cards to people with high credit scores because they are likely to pay their bill on time.
Three years ago, I applied for my first credit card. Since then, I have been able to keep track of my finances, establish a nice credit score and even travel for free using reward points. When used properly, credit cards can be a helpful financial tool to help college students track spending and earn cash back rewards.
College students commonly find themselves in trouble with credit cards. According to a 2016 Experian survey, 58% of college seniors said they have credit cards and 30% said they had credit card debt averaging $2,573. Overall, fewer college students are signing up for credit cards.
Prior to 2009, it was not unusual to see credit card companies setting up booths on college campuses. They were offering a deal no college student could pass up: free food in exchange for a shiny, plastic credit card. College students were easy prey to credit card companies looking to profit from young adults who did not know how to responsibly use a credit card.
The Credit CARD Act of 2009 held credit card companies accountable for transparency and prevented marketing to anyone younger than 21. Now, anyone under the age of 21 must show proof of employment or have a parent co-sign in order to apply for a credit card.
Yes, credit cards are a huge responsibility, but there are plenty of responsible college students out there who shouldn’t be discouraged from using credit cards. Credit cards have many advantages and with the right information, you too can establish credit, eventually qualify for a rewards credit card and reap the benefits. Just follow these steps:
- Determine whether you are ready for the responsibility of a credit card.
Credit cards have an array of benefits but require responsibility. It’s up to you to determine whether you are ready. Unlike debit cards, credit cards have a monthly bill to pay. There are consequences – debt, late fees, a lowered credit score – if you are unable to stay on top of it.
Are you a responsible spender? Hold off if you have spending spree tendencies. Credit cards give rise to overspending. It is essential for credit card holders have a good grip on their finances.
- Sign up for a student credit card.
If you have no prior credit, apply for a student credit card. They will help you phase into the obligation of a credit card and are friendly to the college student demographic. Most student cards will start you out with a low line of credit – about $500-$1,000. Be sure to spend well below your maximum line of credit.
Use it only to buy necessities such as groceries and gasoline. Download the app associated with the card to keep track of purchases and pay your bill anywhere. The purpose of a student credit card is to establish credit and prove you can pay off your bill every month; it does not matter how small the bill may be. Be sure to pay your credit card bill off in full and do not carry a balance.
What does it mean to “carry a balance”?
Carrying a balance is carrying debt. Card holders have the option to pay their bill completely or partially every month. A minimum payment is required but not the total money owed.
Let’s say you spend $300 during one statement period and you pay off $200. That means you carry a balance of $100 into the next month. A compounding problem occurs if again, you spend $300 the next month on top of the $100 balance from last month. Now the new balance is $400. Always pay your credit card bill off in full so you don’t carry a balance. More consequences arise when APR is part of the equation.
What is APR?
The acronym APR stands for annual percentage rate. Many credit cards offer 0% APR for the first year. Which means, if you carry a balance and cannot pay your entire credit card bill during a month-long statement period, then you will not have interest when the balance carries over into the next month. After that year-long 0% APR period ends, the APR can range anywhere from 7-25% depending on your credit score.
Using the prior example, if your credit card bill is $300 but you can only pay off $200, then you carry a balance of $100 into the next month. If your APR is 10%, then your $100 balance becomes $110 – now your bill is $410. Essentially, APR allows credit card companies to charge interest for not paying them back on time. The lower your credit score, the higher your APR rate will be. If you pay your credit card bill off in full every month, APR is a non-issue.
- Upgrade to a basic credit card.
Using a student credit card responsibly for one year should help you establish enough credit history to accumulate a high credit score. Now it’s time to lose the student credit card and trade in for a basic credit card. Look into credit cards offered by your bank. It’s convenient to have your credit card tied to your checking and savings accounts for seamless banking. Look for a card with 0% introductory APR, no yearly fee and applicable cash back.
What is cash back?
Credit card companies offer cash back as an incentive for customers to sign up for their card. For certain purchases, points are rewarded or a small percentage is reimbursed back to the card holder.
If a card offers 5% cash back on groceries and you spend $200 at the super market in one month, then you will receive $10 in cash back rewards. After one year, that could be $120.
- Start earning cash back rewards.
At this point you have proven to yourself and your bank that you are a reliable card holder and your credit score should reflect that. Acquiring more credit history opens the door to cash back rewards.
To earn the most cash back possible, identify your top spending categories and what is important to you. Are you a commuter? Then you want a card offering cash back on gas. Do you love to travel? Then you want a card with airline mile rewards. Do you buy everything from Amazon? The key is to identify your main expenses and profit off of them. Remember, a credit card is most beneficial when you are earning cash back for essentials for which you would otherwise pay with cash or debit.
- Score sign up bonuses.
Once you hack cash back, savvy spenders with a high credit score, high credit limit and inevitable expenses can benefit from sign up bonuses. Elite credit cards, usually with a yearly fee, offer the most cash back. They are attainable with time.
If you qualify for an elite credit card, and if you foresee an expensive and necessary cost, serious money can be made. Be aware that sign up bonuses are time sensitive and purchases must be planned accordingly. Also, be aware that there could be a service fee to use the credit card. Do your research to make sure the rewards will heavily outweigh the credit card service fee.
Your grandma wrote you a $2,000 check for college tuition. A credit card offers $650 worth of travel points if you spend $2,000 in the first three months of opening the card. There is a 2.75% service fee for putting your college tuition on a credit card which equals an additional $55.
This works if, and only if:
- You qualify for the card and your assigned credit limit is more than $2,055.
- You can open the credit card, make the purchase and pay it off immediately.
- You have the $2,055 in the bank with plenty of buffer.
In the end, you earn $595 worth of airline points.
Even if you do not qualify for an elite credit card in the near future, simply being aware that this is a possibility down the road will put you ahead of the game
You may have noticed that you have to acquire a few credit cards in order to work your way up to the one you want. Hopefully each one has a purpose in your life but it may be necessary to cancel an unused card. It is not good for your credit score to have a card with inactivity. Be aware that cancelling a credit card will drop your score slightly and timing is key.
It is important for college students to know about the possibilities that come with responsible credit card usage. Don’t let anyone tell you that you are not ready for a credit card; that’s for you to make the educated decision. There are too many opportunities for success and to redefine the stereotype of a college student credit card holder.