4 credit choices for college-bound students
Co-sign? Secured card? Authorized user? Or (ulp!) a card of their own?
Along with shopping for a mini fridge and extra-long twin sheets for your college-bound kid, have you stopped to think about what type of plastic to send along with your child for emergency expenses?
Having your student open a bank account, complete with their own debit card, is convenient for necessities and for parents to be able to transfer funds. But how would your kid cover the cost of a hard drive meltdown or car transmission explosion?
Few parents hand over their credit card to their college kids to take with them without some major trepidation -- including, but not limited to, sudden heart palpitations and shortness of breath -- but alternative solutions do exist.
Here's a look at your four chief options so you and your student can choose the one that fits as well as those sheets.
The best way to safeguard against any mishaps during the initial learning stages of money management and financial independence is a secured card, says Katie Ross, education and development manager for American Consumer Credit Counseling, a Massachusetts-based debt counseling company. Those carrying a secured card must add a security deposit to the card (the minimum is often $200), which acts as the card's credit limit, so there's no risk a student will rack up a mountain of debt. Your child can't charge more than the security deposit. If a student doesn't pay off the card, the deposit is forfeited.
"If the card issuer reports to any of the three credit bureaus, this type of card will help the student build a credit history," says Ross. Better yet, when searching for a secured card, find one that says it reports the card activity to all three: Experian, Equifax and TransUnion.
Secured cards are notorious for their fees. "College students need to be careful about application, activation and other fees associated with secured cards," says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. In addition to fees, secured cards have much higher interest rates, so a lesson with your student on why it's important to pay off a credit card balance in full every month is in order.
2. Add your kid as an authorized user on your card
Adding your child on your credit card account as an authorized user is the option preferred by NFCC's Cunningham. "This way the young adult begins building their own credit history as all activity is reported in both the parent's and the student's name, but parents have access to the account to view spending online."
"As primary account holder, you can cut off the line of credit immediately if you see your child is using the card inappropriately," adds Kelley Long, accountant and member of the American Institute of Certified Public Accountant's National CPA Financial Literacy Commission.
If your authorized user kid racks up a balance on your card that can't be paid off every month, that will increase your credit utilization ratio, which can dent your credit score. Plus, you could be on the hook for paying off a big bill to protect your credit score. "Card owners are 100 percent responsible for charges made by authorized users, so parents could face a nasty surprise when they get their statements," says Long. That arrangement doesn't necessarily allow authorized users to develop a keen sense of financial responsibility.
"Even if your intent is to teach budgeting, what your child may instead learn is that he has free reign to spend without having to tie that to any type of earning," says Long. A spending contract should be drawn up between parent and child outlining what the expectations are, along with consequences for ignoring those expectations.
3. Co-signing for a card
Due to credit restrictions enacted by the Credit CARD Act of 2009, consumers under the age of 21 cannot obtain a credit card on their own unless they can demonstrate ability to pay (via a steady job or other verifiable income) or have a co-signer. So parents may want to step in and co-sign on a card to give their children the chance to begin establishing credit in their own names.
Even if your intent is to teach budgeting, what your child may instead learn [by being an authorized user on a parent's credit card] is that he has free rein to spend without having to tie that to any type of earning.
American Institute of Certified Public Accountants
This option gives students more autonomy than if they were an authorized user as the bill goes to the student, not the co-signer.
Parents won't have access to the account unless permission is granted by the student, so mom or dad won't see how much is being spent on pizza and beer.
Nevertheless, co-signers are financial liable for the account in the event the primary account holder (your kid) does not pay the bill. Without control over the account, your kid could rack up big debt -- with your name all over it.
Co-signing for a credit card also leaves your credit score exposed. "It isn't a good idea," says Mitchell D. Weiss, economics and finance professor at the University of Hartford in Connecticut.
"Your credit score will take a hit if your child misses a payment or two, or makes payments late," says Ross.
Before signing on the dotted line, consider your child's level of financial responsibility, maturity and impulse control. "You also need to consider that since the card is in the student's name, as the parent you can't cancel it without the student's approval," says Cunningham.
To best protect your credit score, Long suggests that you and your child talk to the card issuer to ask if the credit limit can be set at an amount that you can easily pay. "That way if your student isn't able to handle the responsibility of paying on time and in full each month, you can pay the balance to prevent missed payments from denting your credit score," she says.
4. College kids getting their own credit card
If your child is 21 or older, or younger than 21 and can show proof of income, a card issuer may be willing to give your college-bound kid his or her very own piece of plastic. Cunningham says this puts all the risk on the student, who may lack the emotional maturity to make good financial choices.
This would be a great time to help your child build a credit
score that's worthy of the dean's list by teaching the basic rules of how
credit cards work. "The most important thing for a college student to
learn is what an APR is, how a billing cycle works, why you should pay more
than the minimum payment and to have the knowledge that the card is a walking
loan and is not their money," says Chase A. Peckham, a certified personal finance
counselor and educator at DebtWave Credit Counseling of San Diego.
In addition to the risk that your college kid will graduate with a pile of debt or a flunking credit score, he or she could simply have trouble finding the right card. "There are so many out there and it's hard for someone with no experience or guidance to know to look at APRs and to not be lured by flashy rewards," says Long.
This should really only be an option for kids who've already proven themselves by being authorized users or having secured cards, says Ross.
No matter which type of plastic you choose, it's important for parents to check in frequently with their college kids to see how they are doing with budgeting and spending, especially during that first year away from home. "This is their first time having to account and budget their own money," says Long.
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