I had the pleasure of spending a couple of days with my brother and his family as his daughter is preparing to go off to college in a couple of weeks. She is excited about the adventures and experiences that await her, and is busy trying to get organized with the “stuff” she will need to have prepared.
Interestingly, the subject of credit cards came up and my niece expressed that it was really important she have a credit card to be used only “in case of emergencies”. My niece is one of those people that will give a stranger her last dime and seems to spend $20 when she only has $10. As such, her parents had concerns about her ability to “self-regulate” and not consider charging a bunch of late night pizza’s for her dorm floor as “an emergency”!
However, they know it is important that she should begin to establish a credit record now to be prepared for when she enters the “real world” and needs to get a car, rent an apartment, and get a job (as some employers pull credit reports as part of the job application process).
My brother suggested she do what he did back in the “dark ages” of the 1980’s — sign up for a credit card that first week of school and then she could also get a free mug or t-shirt with the school’s logo to boot! Unfortunately, that is likely not an option for young people in today’s world due to the Credit Card Act of 2009 (Act). The Act substantially changed many credit card industry practices – including provisions designed as a means of preventing students and young adults from getting into heavy credit card debt when just starting out.
Some of the provisions targeted towards these younger consumers include:
- Credit card lenders are no longer able to market pre-screened offers to any consumer under the age of 21.
- Consumers under 21 must have someone who is at least 21 years old (typically a parent or guardian), that passes the lender’s credit screen, co-sign for credit cards, unless they can show proof of income or a means of repaying debt.
- Credit card lenders are prohibited from giving students freebies (t-shirts, coolies, caps, etc.) in exchange for filling out a credit card application.
- Schools and alumni associations are required to disclose credit card “affinity agreements,” where they share student and alumni contact details in return for a revenue percentage when applicants sign up.
- Minors (persons under 21 for purposes of the Act) continue to be allowed as authorized users on their parents’ credit cards.
So what should my niece and her parents do?
Fortunately, there are several alternatives that provide a young adult with access to a credit card or credit card functionality that also have the potential to help build up a credit history.
Standard credit cards
A minor has three main options to secure a “standard credit card”:
- Apply as an individual applicant and show proof of income or a means of repaying the debt that meets the card issuer’s criteria. If approved, the applicant is contractually responsible for the credit and the account performance is reported to the credit bureaus – thus helping to build a credit history. However, it may be difficult to get approved for most young adults.
- Apply jointly – where typically a parent or guardian (or someone at least 21 years of age co-signs — meaning they are contractually liable for the debt) with the applicant for the credit card. If approved, both the applicant and the co-signor are contractually responsible for the credit, and account performance is reported to the credit bureaus on both, thus helping the applicant to build a credit history. However, the co-signor does need to pass the lender’s credit screen in order for the applicant to be approved for the credit card.
- Be placed as an authorized user on a parent’s (or someone at least 21 years of age) existing credit card account. There is no approval process in this option, the existing card holder contacts the credit card issuer and requests that the minor be placed on the account as an authorized user. Once that takes place, the account performance is reported to the credit bureaus as usual on the parent’s credit file as well as on the minor’s credit report.
For a standard credit card, the authorized user option is considered the most favorable by many as it allows the parent to monitor spending and help educate the minor on how credit works while including the benefit of helping the minor establish a credit history.
Other “non-standard” credit card options that can also be considered:
Secured credit cards
This option looks and operates much like a typical credit card, with a monthly statement and cardholder activity typically reported to the credit bureaus that can help a minor establish credit history. The main difference: the card issuers require a deposit upfront ($500 or $1,000 for example) which becomes the card holder’s credit limit less any upfront fees the issuer may apply.
This option looks like a typical credit card and can be used in transactions for goods and services wherever credit cards are accepted. You can purchase these at most banks, grocery or discount stores for single use or reload them with cash when funds are depleted. The amount available to use is the balance you have on the card at that time. You can’t charge more than the balance so there are no interest charges, but there are fees that the user should fully review before signing up.
Pre-paid cards are rarely reported the national credit bureaus so they have little value in helping a consumer establish credit.
Similar to the pre-paid card, but tied to an established checking or savings account. When you use a debit card to pay, the money’s instantly debited from your bank account, rather than accumulating a balance of charges over a 30 day period that may have interest expenses accruing. Debit cards are typically not reported to the credit bureaus so they won’t help a consumer establish a credit record.
So, dear niece (or if you or one of your children is off to school soon), consider these options that will provide your parents with peace of mind and a degree of control should a financial emergency arise where a credit card can help – while you have the opportunity to build up a credit history at the same time.
Tom Quinn is the Vice President of Business Development for myFICO® , and has over 20 years of experience working with consumers, regulators and lenders and regarding credit related questions and initiatives.