Building good credit for college students and recent graduates
Credit is one of the major building blocks of a healthy financial future. Stated most simply, credit is the lending of money with a premium, known as interest, to be repaid over a designated period of time, usually in monthly installments. It is a truism that getting credit helps one to build a credit history because creditworthiness is the measure of one’s consistency in paying back lenders.
Credit on College Campuses
Borrowing against a line of credit has become like a rite of passage in America, and yet another marker of the transition from adolescence into adulthood. It is no surprise then that one usually begins to build credit after high school graduation, usually in the form of credit cards. In fact, discussions regarding college students and credit center mainly on credit cards as they have become a main staple of credit in young adult life.
It is not difficult for college students to begin building credit as credit card companies are more than eager to approve student credit card applications in hopes of students becoming lifetime card holders. Some credit card companies will have ambassadors on college campuses ready to sign up students on the spot, and there are usually numerous credit card applications available in college bookstores. According to College Parents of America, a 2009 study of college students and credit cards found the following:
- About 84 percent of undergraduate college students had at least one credit card.
- Approximately 50 percent of cardholders had four or more credit cards.
- The average college student’s credit card balance was $3,173.
- About 40 percent of college students reported charging items knowing that they could not afford to pay for them.
- Approximately 60 percent of college students stated they were surprised about the amount of their credit card debt.
The best practice for building to credit is to be wise about amount spending, pay off credit card balances as quickly as possible, and stay current with monthly payments. Observance of these points will bring about a good credit score and a healthy credit future.
Having credit generates a credit report that is a snapshot of one’s financial picture and includes present and past credit accounts and their status (such as current or delinquent). A credit score is calculated based on a credit report. Credit scores are also called FICO scores after the company – the Fair Isaac Corporation – that developed the most widely used credit calculation model. Nerd Wallet, which specializes in credit topics, describes credit score ranges as follows:
- Less than 630: This range is considered low, which means that it may be difficult to obtain credit, and when credit is obtained, higher interest rates will apply.
- 630 to 689: This is an average range of credit. One reason for being in this category is having credit cards with balances that are close to the maximum line of credit.
- 690 to 719: This is a good credit range and provides opportunities for low Interest rates and many borrowing options.
- 720 to 850: This is an excellent range of credit and includes the highest scores possible. Creditors are keen on working with people on this level and will offer fringe benefits, like travel award miles on credit cards, to attract customers.
Creditors report a person’s accounts and status on these accounts to three main reporting agencies: Experian, Equifax, and TransUnion. It is a good practice to request and review all three reports after first year credit is established and at least each year thereafter. Credit scores are like financial report cards, and it’s important to be aware of your marks and make sure they are correct.
As the credit score calculation methods are fixed, in the event a consumer disagrees with their credit score, they will need to review their credit reports to determine if there are any errors. Consumers can work with the credit scoring agencies to fix their credit report, which will result in a new, correct score being generated.
Factors Used to Calculate a Credit Score
An understanding of how credit scores are calculated provides guidance on how to responsibly use credit. According to My FICO, the following weighted factors are considered in the calculation of credit scores:
- Payment history: 35 percent
- Amount of debt owed: 30 percent
- Length of credit: 15 percent
- Types of credit consumed: 10 percent
- New credit: 10 percent
The factors underlying credit scores help to demystify the process of building credit for college students. Since student loan repayments are deferred until after graduation, many students may not realize that these loans are helping them to build their credit. As student loans can work out to be a positive from a credit-building perspective, it is important for students to avoid downgrading their credit scores through irresponsible use of credit cards.
TIME Magazine, reporting on credit card literacy on college campuses, found that only 10 percent of students paid their balance in full each month and many were largely in the dark on basic terms of their credit cards, such as the interest rate, late fee, or over-the-limit fees. TIME noted the irony of the findings because it would be expected that students who had the ability to succeed in college-level coursework would also have the ability to manage their finances, but such did not appear to be the case. Further, citing a National Foundation for Credit Counseling survey of adults on the topic of credit, TIME noted an unsettling finding: 56 percent of adults surveyed advised that they wish they could improve their credit score while only 5 percent communicated any interest in understanding their credit score. An understanding of how the credit scoring system works is integral to developing a healthy relationship with credit and an important starting place for college students who are just beginning to build their credit profile.
According to MSN Money, there is no need for students to fear credit, despite some warnings in the media about the burdens of credit card debt on college students. It is noted that in addition to applying for a student credit card, if a student’s parent has good credit then it may be a good idea to be added as an authorized user, which is a relatively easy process that will not involve a credit check. Further, in this way, students and parents can work together to ensure the student uses the shared credit card wisely which will help the student build his credit profile responsibly. Since college does not include personal finances in the core curriculum, it is important for students to look to their parents and reliable informational resources to learn how to successfully build and manage their credit.
There are also ways to build a strong credit profile without borrowing credit, such as opening checking and savings bank accounts. A modest opening deposit is not a hindrance as banks are welcoming of students who they are hoping will bank with them for their entire lifetimes. Speak with local banks to learn about student checking and savings accounts that usually carry low or no fees compared to traditional accounts. A further way to establish credit without borrowing is not to move residences too frequently. Remaining in the same residence is a good indication of stability, although creditors, employers, landlords and other persons reviewing your credit report with understand if you changed residences during college.
After establishing credit, an important step to keeping good credit is to take an inventory of all lines of credit, make a chart of all outstanding balances, and create a plan to pay off amounts owed. If this advice seems difficult to incorporate into your personal finances, consider changing your spending habits going forward and devise a viable long-term plan for paying down your balances to avoid graduating from college with debt. After the initial grace period for student loans (usually six months) expires, repayment will be required and may seem more onerous if you are carrying a credit card balance. Although college can last four or more years, it is advisable to keep post-graduation financial goals in mind and not compromise them by getting into debt that becomes hard to manage.
Good credit management habits developed in college will carry forward and provide an advantage when students face loan management after graduation. Even before the student loan grace period expires, US News advises students to take the following steps to embark on a successful repayment plan:
- Make a list of all federal and private student loan lenders.
- Research the possibility of consolidating federal loans (private student loans are not consolidated with federal loans) in order to receive more favorable repayment terms and interest rates.
- Both federal and private student loan companies offer different repayment plans; find out the eligibility requirements for each plan and the associated monthly repayment amount.
- If you are employed, make a full budget based on earnings and cost of living, and determine which payment plan you can afford.
- If you are not employed, contact the federal and any private student loan companies directly to inquire about deferment or forbearance options (which will suspend your repayment responsibilities until your circumstances change or the approved period of deferment or forbearance expires).
- For federal loans, research the Income-Based Repayment Program, a federally approved program that caps monthly student loan repayments for qualifying students.
Why Good Credit Is Important
Starting and maintaining a strong credit profile is a helpful way to create a wide range of lifestyle options and open doors to future opportunities. According to the credit reporting agency Experian, good credit may not only be desirable but necessary to:
- Obtain a home mortgage
- Lease a car
- Qualify for employment as employers may require job applicants to submit to credit checks
- Be selected for a rental lease on a residence
- Be eligible for bank loans to start a business or expand on one
It is clear that credit scores are increasingly becoming an indication of more than just suitability for credit and gaining an even stronger foothold in the marketplace. For this reason, it is particularly important for college students who are at the start of the credit-building process to take precautions to protect their credit scores and use their lines of credit responsibly in order to procure all the benefits and privileges good credit provides.