There's a big change on college campuses this year. In the past, you would have seen tables outside the student union, featuring logos of banks and credit card companies, luring gullible freshmen with offers of free coupons and T-shirts in exchange for filling out a credit card application. No longer.
This year, President Obama signed the Credit Card Act into law, and a part of it has rules concerning credit card use by anyone under age 21 (go to Title III on page 14 for the details). In short, they can't get a credit card unless they have an independent source of funds to pay the bills. If they don't have that, they'll need a parent to co-sign the card application, and submit written permission from the parent before they can get a hike on their credit limit).
That's good news, because many college students have signed up for a credit card and wreaked havoc on their credit record before they even knew they had one on file. Nevertheless, college is the time for students, many living on their own for the first time, to learn about managing their finances and how to to keep a budget. So if they can't get their own credit card, then what?
Linda Merksamer, a single mom from Sacramento, is wondering just that as her daughter, Christine, starts her freshman year at college. "Chris had a hard time managing her allowance, and kept coming to me for additional money," Linda says. "I want her to learn how to be financially responsible, but I wonder if giving her a credit card at age 18 and living away from home is a good idea."
So for under-21 spenders -- and the parents helping them out financially -- here are four options.
Use a debit card
"If college students have never used a form of plastic before, this type of card is the best place to start," says Farnoosh Torabi, money coach for Credit.com and author of Psych Yourself Rich. Its advantage over using a credit card is that it prevents the user from running up a pile of debt, because he can only use the allotted funds in the banking account linked to the card.
However, it is possible that a debit cardholder could exceed the balance. That's why users should take advantage of the new Credit Card Act provision requiring banks to allow customers to opt out of overdraft protection. "Otherwise, you could get dinged with a $35 overdraft fee every time you go over," says Torabi. "So tell your bank that you don't want that protection, and if your balance is zero, no more transactions are allowed."
Debit cards do require frequent monitoring to determine how much is left in the account, so it's important that students should learn how to balance the checkbook, or at the very least, check their account balance online. Torabi says she learned the hard way not to go over her debit card limit, when her card was denied while she was standing at the cash register in the mall with a long line behind her. "I used to rely on my ATM receipts to see what left in my checking account, but that's not an accurate tally because there may be a few other purchases you made that haven't been deducted from your account yet."
Become an authorized user of your parents' card
Mom and Dad can give you your own card that ties to their credit card account, so that you're an authorized user. But parents, you can make sure your kids don't go on a shopping spree. Set limits by telling your card issuer that the youngest authorized user can only charge up to a certain amount over a certain time period, for example, no more than $500 per month.
"The advantage is college students can start establishing their credit histories," says Torabi. "The downside is that if the parents get into some financial hardship and default on their credit card debt, their children, as authorized users, will also be affected."
Get a secured card
Consider this a credit card with training wheels. A secured card is typically geared for people who've been denied credit; the bank does not want to take the risk of giving them a credit limit so it asks for collateral to cover it. That means you must load this card with your own money, typically up to $500 or $1,000. From then on, you use it like a real credit card.
"Once you prove to the bank that you can pay off your bill in full, the same time next year, it will convert the secured card into a credit card or give you a real one with bank money and a higher limit, " says Torabi. "It's a good option for students because a $500 monthly limit is really all you need, and it's a good way to establish credit. By the time you're 21, you can get a really good credit card with a good interest rate."
Parents can co-sign a credit card
The Credit Card Act does allow parents to co-sign a card for their under-age-21 child, but Torabi says this should be the last-place option to consider. "The big risk is that both parties are responsible for the debt. If a student racks it up, it becomes the parents' responsibility."
However, if parents trust their child enough to handle a credit card, Ken Lim, CEO of credit advice website CreditKarma.com, says they should teach him the fundamentals of owning a credit card prior to getting one.
"Educate him about the terms, such as the payment schedule, fees and interest rate. Explain what a credit limit is and how he will be hit with a fee if he goes over it. And it's extremely important to educate him on the importance of paying on time and how this influences building a good credit history." To safeguard against late fees, set up automatic bill payments to guarantee the card is paid on time each month.
Lin also advises setting limitations on what purchases should be put on the card (books and school supplies) and which ones shouldn't (food and clothes). To keep track of how the card is being used, parents should go over the statement with their kid each month to make sure she's sticking to the plan.
Any option can be a good credit-building tool
After discussing all the options above, Linda and Christine Merksamer decided that Christine would get a debit card tied to a bank account that Linda would fund quarterly, and Christine would have a monthly limit to stick to. Says Linda, "If she proves that she can stick to the monthly limit during her freshman year, then next year we'll talk about getting her a secured card or adding her as an authorized user of my credit card."
While it's not always a good idea to give an 18-year-old new to college a credit card with a high credit limit, is is wise to give him a method of building a credit history and learning how to budget. "The earlier you get the lessons and the experience, the better you'll be at age 21 when you're eligible for your own credit card," says Torabi. "And the better off you'll be at managing your finances for the long run."
Debit or credit: What card type is better for college students?