Sometimes a little debt can be a good thing. The Project on Student Debt recently reported that the typical college graduate last year had acquired $26,500 in debt over four years, a 5% increase from 2010. But Lynnette Khalfani-Cox, author of “Zero Debt: The Ultimate Guide to Financial Freedom” and “Perfect Credit,” said this debt won’t prevent most graduates from obtaining a credit card. In fact, some student debt is healthy and can help establish a credit rating.
Three main factors explain why most college graduates are denied a credit card: 1) bad credit, 2) limited credit, and 3) no credit. Bad credit stems from not having repaid a debt or making late payments. If you have received collection notices or had something repossessed, you have bad credit. Limited credit is attributable to those who took out a student loan or paid off previous bills, but only for a short period. And no credit is for students that never had bills to pay and never established any credit lines.
“College debt can help a college student, as long as it’s not overly excessive,” Khalfani-Cox said. If a recent graduate earns $25,000 a year and has amassed $100,000 in student loans over four years, most credit card issuers balk at offering more credit, and will likely reject a new card application. Also, extending student loans from 12 to 25 years can also serve as a deterrent to obtaining a credit card.
Before the Credit Card Act of 2009 was passed, a college graduate could obtain a card based on household income, but now issuers must judge applicants on their individual income as well as their credit rating. In fact, the law prohibits anyone under 21 from being issued a credit card unless the applicant can demonstrate steady income or have a parent or spouse with sufficient earning power co-sign for them.
Effect of a Student Loan Default
If a graduate defaults on a student loan, it makes obtaining a credit card difficult. According to the Department of Education, the number of borrowers defaulting on student loans in 2010 rose slightly to 9.1%, compared to 8.8% the previous year. A default can be devastating to a credit score and reduce it by 50 to 100 points if it is several months overdue.
If a graduate is rejected for a credit card, one option is to consider getting a secured credit card. With a secured credit card, the applicant deposits money, which establishes their spending limit. It’s like a lender providing collateral for a loan, which eliminates risk for the bank. But there’s a catch with secured credit cards. Many have high annual fees and high interest rates.
If rejected for a credit card, another option is “piggybacking.” The card is issued under someone else’s name, like a parent or spouse, but the recent graduate receives a card in his/her name. The parent or spouse is ultimately responsible for paying the bill, and the graduate can write a check to their sponsor.
Khalfani-Cox said the best way for a recent graduate to obtain a credit card is to pay off their college loans in a timely fashion, pay their bills on time, and build a strong credit score. She also suggests graduates monitor their credit ratings at the three major agencies (Equifax, Experian and TransUnion) and dispute any mistakes.
Paying off credit card debt first makes the most sense for a recent graduate. Credit card issuers penalize consumers for carrying too much credit card debt, but not for student loans. If a graduate is rejected by an issuer, try applying for a different card. Persistence pays off in credit card applications, just like in life.
Gary M. Stern writes for Fortune.com, Investor’s Business Daily, and CNN/Money and co-authored Minority Rules: Turn Your Ethnicity into a Competitive Edge (Harper Collins).