As the clock winds down on an era of easy credit card access for youths, young adults must find new ways to develop positive credit histories.
After February 2010, adults younger than 21 may only obtain a credit card if they can demonstrate financial independence or get a parent to co-sign and take responsibility for payment if the young adult fails to do so. These new requirements are part of the Credit CARD Act of 2009, a nationwide reform aimed at instituting more consumer protections.
While access to credit shrinks for young adults, there remains a growing need for young people to prove financial responsibility by demonstrating a history of faithful payments, says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling, a national network of nonprofit credit counseling agencies. Ever-cautious lenders that control access to car, credit and housing loans, want to ensure their borrowers are safe investments, and do so by checking consumers’ credit and payment histories.
“I would like to see students graduate with big and positive credit files,” says Cunningham. “If they want to get rid of that old clunker and get a newer vehicle, they will have an easier time doing so if they have a bigger credit file. It’s the same with getting a house and landing that dream job.”
In fact, an increasing number of employers are looking at a potential employee’s credit history before extending a job offer, she adds.
Since young adults who choose full-time jobs instead of attending college will more likely be able to qualify for credit cards, students under 21 will more likely face a difficult climb toward respectable credit records.
The Federal Reserve recently released rules outlining what form of proof is needed to determine how a person qualifies as financially independent. “The Board believes an evaluation of a consumer’s current ability to pay must include a review of the consumer’s income or assets as well as the consumer’s current obligations,” says the Fed.
Here are some alternative ways for students to build a credit history:
Piggybacking.Piggybacking is when a student becomes an authorized user on a parent’s credit card account. Students receive their own cards and may use them, but have no legal responsibility to pay. All charges, no matter who made them, are the ultimate responsibility of the primary account holder.
When the card company reports the payment and account status to the credit bureaus, both the student’s and the parent’s credit reports reflect that activity. If students abuse their card-carrying power by overcharging, the parent can revoke their access to the account. Potential problems can arise if the parent’s credit begins to deteriorate. In that situation, both the parent and the child receive a negative report.
Co-signing with a parent. Getting a parent to co-sign on a credit card is the alternative credit-building method proposed by the CARD Act. This is when a parent agrees to assume responsibility for any card debt accumulated by the student. The student receives all bills — though the parent can request copies of the monthly statements — and is expected to be the primary person responsible for the account. However, if the young adult becomes unable to pay on the account, the responsibility to pay then falls to the co-signer. Both are legally responsible for resolving the debt. If the co-signer can’t pay, both their credit reports will be blemished.
A late payment by the student also negatively affects both parent and child. The amount of control a parent has over the account is minimal. Co-signers do not have authority to close the account if their student overspends because they do not own the account — the student does.
“They may address the lender and attempt to withdraw their guarantee,” says Dave Jones, president of the Association of Independent Consumer Credit Counseling Agencies, a national nonprofit organization involved in credit counseling services. “There is no assurance that this will be successful (especially if there is an existing balance). If they want to make their withdrawal certain, they will likely have to engage legal counsel.”
A less risky alternative to co-signing is to add a child as an authorized user to one’s account.
|— Karen Klugh|
American Financial Services Association
One Discover Card spokesman says the rights of co-signers are still extremely unclear. Discover is still awaiting clearer guidelines from the Fed.
“A less risky alternative to co-signing is to add a child as an authorized user to one’s account,” says Karen Klugh, communications manager for the American Financial Services Association, a trade association for the consumer credit industry.
Adding a child as an authorized user, or piggybacking, may be less hazardous for the parent because his or her credit report doesn’t hinge on the student’s payment or lack thereof.
Prepaid cards. A few prepaid cards — reloadable cards on which consumers place money and then use like debit cards to make purchases — can help build credit. Not all cards offer credit-building features and those that do may not be comparable to more traditional methods of creating credit histories. Some prepaid cards report to alternative credit card bureaus, which are not one of the big three traditional reporting agencies– Experian, TransUnion and Equifax. If the company doesn’t report account activity to one of the traditional credit bureaus (and most don’t), then the student’s ability to qualify for a loan or credit card will be hindered if the lender chooses to judge a potential borrower by using reports from a traditional bureau rather than a nontraditional bureau.
Make sure to read the fine print and ask if the issuer reports payments to a traditional credit bureau.
Secured cards. Until February, students under 21 may obtain secured credit cards— a card with credit limit equal to the consumer’s cash deposit — without parental permission. Once the legislation goes into effect, students will most likely need an adult co-signer.
With secured cards, the value of the deposit becomes the student’s credit limit. If the student is unable to pay, then the deposit may be taken and used to cover the debt. If the student pays on-time and in full, then the deposit may be returned once the account is closed. These cards differ from prepaid cards because students are actually being extended credit — the credit is just backed up by the initial security deposit in case of an inability to pay.
Though most experts see little or no risk of financial ruin arising from secured card use, the Fed has made no indication that these cards will be exempt.
Keep in mind that secured cards may come with high fees, so it’s important to read the fine print to see the actual costs. Plus, not all secured cards report payment history to the credit bureaus, so ask upfront if a particular secured card issuer reports account information to one or more of the top three credit bureaus.
Get a credit card while there’s still time. Students over 18 may still get their own cards without a parent’s permission before February 22, 2010.
Not all methods of payment help build credit histories. Credit bureaus only record activity on accounts that involve consumers borrowing money from lenders or service providers. If the consumer already “owns” the money (such as on most prepaid cards), then the account will not be included as part of that person’s credit history.
Cash (unless from a loan) and debit cards are not forms of credit so they won’t create or improve credit records either.
“A debit card is in no way a form of credit,” says Ed Mierzwinski, who serves as consumer program director of U.S. Public Interest Research Group, a public interest organization. “Only credit and loans build up a credit bureau report and score.”
He adds: “A Visa or MasterCard logo doesn’t make a debit card the same as a credit card. And selecting ‘credit, not debit’ merely moves a transaction through the bank-preferred offline system rather than the PIN system.”
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If a prepaid or debit card is being used to pay bills, then those payments will be reflected in a credit report — not because the report includes on-time payments but because nonpayment will be documented.
“Making payments on time and in full or at the required minimum amount will reflect positively on your credit history,” says Klugh. “Anything less than that will reflect negatively.”
Some financial transactions that can impact your credit report can include cell phone, utility, health care and rent payments. Failure to pay these bills on time and as agreed can hurt a person’s credit standing.
“Using your debit card to make payments for cell phone service, utilities, etc. helps ensure that your payments are on time and thus indirectly affects your credit score,” says Klugh.
All potential credit-building activities require research to determine which method is best in a particular situation. Both Cunningham and Klugh encourage educating children on financial issues before arming them with plastic.
“Before applying for credit, students need to know what they’re getting into,” says Klugh.
“I would not recommend that anyone dive into the world of credit who has not had financial training,” adds Cunningham. “That’s why the NFCC recommends financial training in the home, where there is a safe and soft landing if they fail.”
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