The Consumer Financial Protection Bureau (CFPB) has recently sounded an alarm, by releasing a report that compares education financing practices to subprime mortgage lending. The CFPB report had indicated that private student loans saw a tremendous increase from $5 billion in 2001 to over $20 billion in 2008. Although by 2011 student borrowing shrank to $6 billion, the effects of pre-recession lending are still felt today.
The report says that non-government lenders approved credit without considering the ability of students to repay debt. According to the study released on Friday, the lenders resold these loans to private investors; shifting away their risk of losing the money when students default. In an interview with Financial Times, CFPB student loan ombudsman Rohit Chopra said that “Policymakers cannon sit by as passive observers. While regulators are trying to sway politicians and their support, it’s in students’ own hands to protect themselves against growing debt.”
With all above said, is it a good idea for a college student to apply for a credit card?
Let’s see. A credit card can help a young person lay a foundation for their credit history. Having a credit card provides a sense of security in case of an emergency. It also teaches kids valuable lessons of independence and responsibility. However, if a student fails these life lessons, his or her whole life may change for the worse.
What Students Need To Know
- A credit card must be paid every month, preferably in full. A balance that revolves on a card from month to month is subject to interest charges, which are added to cardholder’s total amount of debt. If there is a balance, one can pay dearly for missing payments: late fees, high interest rates, and negative report at the credit bureaus – all of this can become an obstacle in young person’s future ability to function in a society – such as getting a job or a car loan.
- When bank issues a credit card, it suggests a minimum payment. But that is never to your advantage. A credit card monthly payment should be twice the amount of a proposed minimum payment stated on a monthly bill. This is because it could take years to pay off a smallest amount if only minimum payments are made. A simple $1000 charge can quickly relate the staggering amount of years it would take to pay-back at a rate of 15% interest. With a $20 monthly payment it will take 7 years to pay-off $1000 and will cost additional $580 in interest charges, if no additional purchases are made.
- Never consider credit card as a free bag of money. Being responsible means living within means of income. Consider spending on a card only what you can afford to pay back. It’s easy to splurge when you are in college. Having friends can be expensive and a student may be tempted to treat friends with a slice of pizza or more. Consider using a credit card only for necessary purchases, like textbooks and study accessories.
- Further, each credit card, unless it’s a charge card, has a credit limit. Remember this number: 30% – this should be a maximum portion of your total available credit limit that may be spent on the card. It’s called credit utilization ratio, and it plays a big role in credit score calculations.
Students should learn and take advantage of simple banking applications offered by major banks. These useful tools allow you to monitor spending, set financial goals, and keep track of monthly payments.
Now That You Are Warned Let’s Build Credit
There is a very simple and healthy philosophy behind responsible credit card use. These ideas will help a student not only build a good credit, but become organized and be a better student. Consider these four important rules:
- Set a monthly budget and live by it – do not overspend.
- Set a day to mail your payment, repeat it every month. For example a third Wednesday of each month could to be a perfect day to mail a payment check to the card issuer. This way your check will arrive on time and you won’t chance missing the deadline.
- Learn your credit card in detail. For example, your card may offer cash back on shopping categories that rotate every quarter, and may include a department store where you like to shop. However, to get the reward a cardholder must enroll into the cash back program. Knowing how to use your financial tools can help you earn extra money.
- Keep a close eye on all your transactions. Identity theft is a number one type of cybercrime today. An unrecognized transaction can be disputed; because by law a cardholder carries zero liability for unauthorized and fraudulent transactions. If you see a transaction you don’t recognize, call your bank immediately.
Keep a cool head about using a credit card, but understand that having a credit card is a necessity on many levels. But most importantly its responsible use is an investment that will pay-off later in life.