Five Lessons in Credit Card Risk You Need to Know
College students each year are inundated with pre-approved credit card offers. The card companies want new customers, understandably. The students want to buy things, understandably, and they don't yet have jobs and Mom and Dad's largess is drying out. The result is that a lot of students get caught up in a lot of debt and have no way of digging themselves out.
Nobody teaches students the risks of indebtedness -- certainly not the schools that often contribute to indebtedness -- so we have a credit card curriculum, filling in for what nobody teaches.
Course One: The truth about credit cards
A credit card is a method of payment that allows you to purchase goods and services with money you borrow. If you don’t pay back the money on time — that time period varies but it’s generally one month — you are charged interest.
Think of it this way: when you purchase something with a credit card, you buy that thing and buy the debt equal to the value of that thing. Thinking of your card as a “debt buying device” will help you use the card responsibly.
The take-away: Ask yourself: Do I really need to buy the debt for this?
Course Two: The advantages of credit cards
Credit cards enable you to develop credit. A strong credit score will earn you the best interest rates if and when you take out a large loan to buy a house, a car, or start a business. The length of your credit history is one important factor that determines your credit, so it’s beneficial to get a card early and use it — so long as you do so responsibly.
Credit cards also protect you. If a merchant overcharges you or your identity is stolen, you can call the credit card company and have charges removed. Companies will generally notify you immediately if they see anything suspicious. Many credit cards will even include warranties on goods purchased with the card.
Lastly, credit cards give you the everyday convenience of buying something you can’t pay for at that exact moment. A man who forgot his wallet and couldn’t pay for his dinner invented the credit card to function as a convenience device. That story, it turns out, is only a parable but the intention is clear: credit cards are tools that enable you to make essential purchases when you need them. They are not permission to spend beyond your means. The notion that you can buy something now and figure out how to pay for it later is how credit card debt begins.
The take-away: Purchase things you can pay off immediately -- with cash savings if you don't yet have a steady source of income.
Course Three: The evils of credit excess
Credit cards are bad when you buy more with them than you can afford. Credit cards make it all too easy for this to happen by delaying transactions on your statement, obscuring interest rate charges through complicated equations, and incentivizing spending through rewards programs.
A good credit card formula is this: only spend what you can pay back by the end of the month.
The take-away: Consider using a secured credit card to establish a credit history. These cards require you to make a cash deposit to use as collateral instead of giving you “free” money. Also, consider putting small recurring subscription payments on a credit card such as Spotify, Amazon, or Netflix, then set up an “auto-pay” system to automatically pay the card off at the end of every month from your bank account.
Course Four: Your credit score and you
A FICO credit score is a measure of your creditworthiness; it tells lenders how likely you’ll be able to pay them back. Credit scores range from 300-850, with anything above 750 considered “excellent” (and some people strive for perfect credit scores). Think of a lender as a friend who’s trying to determine if you’re “good for it.” FICO calculates your score using the following information:
- Length of credit history. How long have you used credit?
- Payment history. When you’ve used credit, have you paid in a timely fashion?
- How much you already owe. Why would I lend to someone with outstanding debts?
- The types of credit you’ve used. What other kinds of credit do you have?
- And if you’ve recently sought new credit. So you’re not just asking me for money...
Credit Score Ranges and Quality
|Credit Score Ranges||Credit Quality||Effect on Ability to Obtain Loans|
|300-559||Very Bad||Extremely difficult to obtain traditional loans and line of credit. Advised to use secured credit cards and loans to help rebuild credit.|
|560-649||Bad||May be able to qualify for some loans and lines of credit, but the interest rates are likely to be high.|
|650-699||Average/Fair||Eligible for many traditional loans, but the interest rates and terms may not be the best.|
|700-749||Good||Valuable benefits come in the form of loans and lines of credit with comprehensive perks and low interest rates.|
|750-850||Excellent||Qualify easily for most loans and lines of credit with low interest rates and favorable terms.|
Carrying a credit card balance and paying interest on that balance does not improve your credit. Paid interest is not reported to credit bureaus. The only thing they see is your credit usage (i.e. what percentage of total credit are you using month-to-month) and your payment history on that credit (are you paying on time). Paying interest on what you owe does not build trust. Paying what you owe builds trust.
Many websites offer to compute your credit score for you, but AnnualCreditReport.com is the only authorized site for your free credit report, as mandated by the FTC. You get one free report a year by U.S. law. If you need another report, consult this page for a list of reliable free credit reports.
Course Five: Nothing is truly free
“Free” credit report services often sell your contact information to credit card companies, which will flood your mail with pre-approved credit card offers.
The takeaway: Visit optoutprescreen.com website accredited by the Fair Credit Reporting Act (FCRA) and op-out from receiving spam mail for five years.
We hope these credit card lessons will help you develop credit in a responsible way. If you have good credit habits, congratulations! Share this information with a student who might need it.