Student Guide to Building Credit
With minimal experience in financial management, it’s all too easy for students to become overwhelmed with unnecessary debt. Although the 2009 CARD Act took aggressive steps toward curbing predatory practices used by credit card providers to lure college students, young people still need to prepare for adult life in our credit-based society. Building a good credit history is critical for functioning in the modern world. From buying a car or house to acing an employer background check, students must understand how to build a credit history responsibly.
This article will discuss the importance of ‘credit scores’, explain how these figures are calculated, explore methods of improving one’s credit history, and share some strategies for avoiding the most common financial mistakes that students make.
Why Credit Scores Matter to Students
Whether they have reviewed it firsthand or not, every adult in the United States with a credit card and/or a bank loan in their name has a personal credit history. According to the U.S. Federal Consumer Information Center, the following information is included in a standard credit history report:
- The individual’s name, address, and Social Security Number
- The number of active credit cards currently held by the individual and the amount of available credit remaining on each one
- All of the individual’s past loans (both loans that have been repaid and those with outstanding debt)
- The amount of money currently owed by the individual (this may apply to credit cards and/or loans)
- The individual’s record for paying bills on time
When someone requests a loan or credit card, the provider may access that person’s credit report to determine whether or not they are a good candidate. Employers and landlords may also review the credit reports of applicants. If you would like to receive a copy of your credit report, this information is available through three credit bureaus: TransUnion, Equifax, and Experian. Each company will provide one free credit report per year; by staggering this annual allotment, you can receive a free statement of your credit history every four months.
However, you’ll need to pay to see your ‘credit score’ ― a number that reflects all the different aspects of your credit history. Each of the bureaus uses a different formula to calculate credit scores; in addition, the Fair Isaac Corporation (a corporate financial consultancy based in California) provides what is known as the FICO Score, and numerous other companies have begun to calculate credit scores using their own proprietary algorithms. But generally speaking, a credit score will fall between 300 and 850; the higher your score, the better shape your credit is in.
According to Bank of America, your credit score may impact your day-to-day life in the following areas:
- Employment: Many employers use credit scores to measure an applicant’s level of responsibility and maturity. If your score is low and your credit history has any red flags, it’s likely that the job will be awarded to someone else ― especially if the position involves accounting or financial management.
- Property rental: If your credit history indicates you are not reliable when it comes to making monthly payments, then a landlord or property manager may assume you can’t be counted on to pay rent on time.
- Car loans and insurance: Car loans and auto insurance premiums are often determined by one’s credit history, with the best deals awarded to ‘qualified buyers’ with attractive credit scores.
- Utilities: If your credit score is high, then you may not have to pay a deposit to your electric company, water supplier, and other local utilities ― as well as cell phone providers ― when opening up a new account.
- Credit cards: Whether you are approved for a new credit card or not will depend heavily on your credit history.
How to Establish a Strong Credit History
There are many proactive steps you can take to build a positive credit history and ensure your credit score remains high. Kiplinger contributor Erin Burt notes that the following strategies will effectively help you remain in good standing with credit bureaus.
- Create a bill payment schedule: Forgetfulness when it comes to paying bills on time is a constant headache for busy students; one late payment could affect your credit score for up to seven years. You can somewhat mitigate this problem by marking all of your financial deadlines on a calendar, and then paying your balance as soon as the bill arrives each month. Bank account-holders can use software programs like Quicken or Microsoft Money to schedule automatic withdrawals from their checking or savings accounts; by keeping track of your balances, you can pay your bills on time without worrying about overdraft fees. If you have a monthly credit card bill, it might also be a good idea to pay slightly more than the minimum balance ― as long as you can afford to do so. If your bank doesn’t offer automatic bill pay services, start by making a ‘bill checklist’ that includes the following regular payments:
- Utilities (gas, heat, water, recycling, etc.)
- Credit card debt
- Auto insurance
- Cable, phone, and Internet service
- Avoid maxing out your credit cards: Many lenders will determine if you qualify for a loan by reviewing the amount of credit remaining on each active card. Author Liz Pulliam Weston, who wrote Your Credit Score: How to Fix, Improve and Protect the Three-Digit Number That Shapes Your Financial Future, advises students to keep their spending on each card below 30% of the available credit. If your card has a $1,000 limit, for example, then you should keep your monthly spending to $300 or less.
- If possible, pay off your credit card each month: The idea that maintaining a balance on your credit card improves your credit score is a common misconception; credit reports do not actually include this information. Burt urges card-holders to limit their spending to small purchases, and then pay the balance in full each month.
- Maintain a healthy checking and savings account: Banking activity will appear in your credit history. Lenders often refer to your record of depositing and withdrawing to measure your personal level of financial stability. By the same token, overdrawing your account or writing a check that bounces will lower your credit score considerably.
- Start out with a secured credit card: If you do not have any credit cards in your name, then owning a secured card can build good spending and repaying habits without jeopardizing your credit score. You can obtain a secured card by making a deposit with your bank or credit union; this amount will serve as your spending limit. If you are unable to pay your bill, the lender will access the money in your deposit to cover the monthly balance. Interest rates and processing fees will vary between secured cards, so a little preliminary research will be needed to ensure you get the best deal available. After one year of responsible payments, you’ll be in the right frame of mind to obtain an unsecured card.
- Obtain a credit card in college ― and use it responsibly: Historically, college students have struggled to make credit card payments on time. For many years, lending institutions were partially to blame; cards awarded to students often carried high spending limits and hidden fees, and soon the card-holders faced insurmountable debt. These practices were somewhat quashed by the Credit CARD Act of 2009, which aimed to increase transparency during transactions between lenders and consumers. However, college students still need to ‘read the fine print’ when it comes to choosing a credit card; variable aspects of different cards ― such as annual fees, interest rates after the first six months, and fraud protection ― should all influence your decision. Also, it’s important to note that most credit unions will not award cards to anyone younger than 21 years of age unless a cosigner is willing to vouch for them.
- Utilize alternative forms of credit: Many retail clothiers, gas stations, and other businesses allow customers to use store credit when making purchases. These cards are relatively easy to obtain, but having too many active accounts will ultimately hurt your credit score ― so try to keep the number limited to one or two. You may also be able to utilize your parents’ credit card in college ― but since the card is in their name, you should always make payments on time to ensure their credit score remains high. Finally, you can ask your parents (or other responsible adult) to cosign for a loan ― bearing in mind that failure to repay the debt will not only hurt your score, but also that of your cosigner(s).
Student loan debt will also affect your credit score ― especially when you make late payments. According to Barry Paperno of Credit.com, student loans can impact your credit history in the following ways:
- Payment history: Student debt will positively affect your credit score as much as active credit cards. If you pay your monthly balance on time, then your score will improve; if you make late payments, your score will suffer.
- Current debt: Student loans do not carry the same weight as credit card debt when it comes to your credit score. However, your score will drop by a few points when the loan repayment balance is high; this will be the case if the loan is new, or if you have deferred the debt. You can raise your credit score by always making payments on time and only deferring your debt if there are extenuating circumstances that require this action to be taken (such as active military service).
- Credit mix: Student debt will not automatically decrease your credit score. For example, if you are repaying a loan and you also have one or two credit cards in your name with a strong history of paying monthly bills on time, then your credit score may actually go up as a result.
Avoiding Common Credit Pitfalls
Even responsible college students can make financial mistakes that will haunt them (and their credit score) for years to come. By understanding how credit works and employing effective strategies for keeping your credit score high, you can avoid these costly pitfalls and enter the real world with a strong credit history.
First, it’s crucial to stay on top of your credit history as soon as you receive your first loan or credit card. Take advantage of the free credit reports made available by TransUnion, Equifax, and Experian, and invest in access to your credit score at least once a year. According to CBS News, less than 5 percent of U.S. citizens accessed their credit score between 2004 and 2010.
However, your credit score will be meaningless if you don’t understand its value. This interactive tool from America’s Debt Help Organization enables you to input your credit score and see how banks and lending institutions view it. Generally speaking, a score below 550 is considered ‘bad’, while any score between 550 and 650 is seen as problematic. It’s important to note that the value of a college student’s score will differ from that of an employed adult in their 30s or 40s; it’s much harder for the former to achieve a perfect or near-perfect credit score, but students who pay their bills on time and minimize their number of active credit cards can easily earn a score of 650 or higher.
Regularly checking your credit history will also reduce the likelihood of errors or mistakes that erroneously influence your credit score. According to CBS News, similar names or Social Security Numbers are often to blame for incorrect credit reports. Even if you detect an erroneous address, misspelled name, or other mistake that has little to no bearing on your credit history, you should still report these inaccuracies to the credit bureau because it might indicate someone else’s financial history is contributing to your overall score. In accordance with the 2003 Fair Credit Reporting Act, credit bureaus must contact you within 30 days if you report an error in your credit history.
If you find yourself overwhelmed by debt, there are still ways to manage the repayments without tarnishing your credit score too much. One way is to restructure your credit card debt by enrolling in a ‘hardship program’. However, Fox Business contributor Roman Shteyn notes that card-holders should inquire about this option before they fall behind on their monthly bills. “Using delinquency as a strategy to get your creditor to work out a deal with you is a bad idea,” he writes. “You’ll get a more sympathetic ear if you approach them prior to missing a payment.” Also, individuals who enroll in hardship programs will lose access to their credit card; in many cases, charging privileges will be suspended until the repayment process has been completed.
For individuals whose debt becomes completely unmanageable, declaring bankruptcy may be the best option. The American Bankruptcy Institute notes you may be a good candidate for this measure if one of the following scenarios applies to you:
- Your wages have been garnished and/or your accounts have been frozen as the result of a legal judgment
- The bulk of your debt is from ‘unsecured loans’, such as medical bills
- Debt collection agencies have begun to contact you at home or at your workplace
- A lawsuit has been successfully brought against you
In the event that you think you need to file for bankruptcy, your first step should be to enlist in the services of a licensed attorney. He or she will assist you with the legal procedures, inform you of all important deadlines, and dispense advice that will help you get back on your feet. Those who file for bankruptcy will also be required to first undergo credit counseling from a government-certified counselor. These individuals will help you explore alternatives that will not hurt your credit score as much as bankruptcy, such as restructuring payments or consolidating debt.
If you decide to file for bankruptcy, be sure to promptly contact all companies and institutions with which you currently have debt. By law, they are not allowed to collect payment from you once you are officially bankrupt.
However, it is important to note that not all debt is easy to erase during bankruptcy filings. Kathleen Michon, a legal editor and author at Nolo, states that it is generally difficult to have student loan debt removed unless there are extenuating circumstances, such as poverty or an inability to make payments despite proven effort. With that said, having your student loan debt included in your bankruptcy is not impossible. The final decision will be based on a number of factors, and may be influenced positively by low income or debt incurred from a for-profit institution.
Loan default is another hazard of borrowing money from lending institutions. If you face a staggering amount of student debt, then you run the risk of defaulting on your loan payments and greatly damaging your credit score. According to the Federal Student Aid Office of the U.S. Department of Education, students can minimize their risk of defaulting by taking the following measures:
- Understand the loan agreement: When a loan is issued to you, review the cost of receiving the loan, the nature of the interest rate (variable vs. fixed), and the terms of repayment. You’ll also be asked to sign a promissory note, a legal agreement to repay all of your debt whether or not you ultimately finish college and earn a degree.
- Avoid borrowing the maximum amount: Calculate your total expenses to determine exactly how much money you need to borrow, and refer to this amount when applying for the loan. If the offered loan exceeds this figure, then you can request a smaller loan.
- Keep track of your loans: If you borrow from the federal government, you can monitor your loans using the National Student Loan Data System for Students. If your lender is a bank or other private institution, then be sure to inquire about online tracking systems that serve the same purpose.
- Maintain thorough records: The Federal Student Aid Office urges you to organize the following documents in a single file, and to keep that file in a secure place (such as a safe deposit box or your parents’ residence):
- Records of financial aid disbursement
- Entrance and exit loan counseling documents
- Promissory note(s) and account numbers for each loan
- The amount of your total student debt
- Lender contact information
- Loan disclosure statements
- Schedule of outstanding balances and a record of monthly payments
- Records of phone calls or in-person visits made to all lending institutions, as well as notes that detail each conversation
- Deferment or forbearance notices
- Receipts or invoices indicating you’ve paid off your loans
Additionally, if you are unable to make a monthly payment for your student loans, you may be able to employ the following strategies:
- Extend your payment deadline
- Switch your repayment plan to receive a lower monthly balance
- Obtain a deferment or forbearance, which are typically granted to graduates with certain extenuating circumstances, such as a major financial hardship or an unexpected illness
- Consolidate all loans; this may extend your window of repayment and simplify the payment process, but it will also increase your interest rate
If you find yourself in a truly desperate financial situation, you may be forced to default on your student loans and incur all the penalties associated with this action. According to the Federal Student Aid Office, you are considered in default after failing to make monthly payments in a certain window period (typically nine months).
If you are forced to go into default, immediately contact each lending institution and speak with a representative who can fully explain your options. These may include:
- Loan repayment: If you can scrape together enough money to pay off the loan, then your default will typically be dismissed. However, depending on the terms and conditions of the money you borrow to repay the loan, this may just transfer your debt to a private lender and the cycle will continue.
- Loan consolidation: By consolidating all outstanding loans into a single loan with a fixed interest rate, you can make your student debt much more manageable. However, please note that consolidation will typically incur a processing fee that may total as much as 18.5% of the original debt.
- Loan rehabilitation: This option involves adjusting the terms of your loan repayment to better reflect your earnings and make the debt more affordable. Rehabilitating the loan may reinstitute certain benefits of the loan (such as eligibility to defer, receive a forbearance, or have the loan forgiven after a certain amount of time has elapsed); rehabilitation will also ensure your default does not appear in your credit report.
Students who utilize credit cards and obtain loans run the risk of facing a myriad of financial headaches down the road. However, the financial management techniques listed above ― such as paying bills on time, carefully reviewing the terms of loans, and regularly reviewing your credit history ― will help you not only mitigate these pitfalls, but also improve your credit in the long-term. Remember: long after you’ve graduated and entered the real world, your credit score will reflect the financial choices you made in college.
If your goal is to improve your credit score, or to simply learn more about your own credit history, print off the following checklist and keep it in a file with other pertinent information, such as your free annual credit report.
- Get educated about your own credit history by obtaining a free credit report from one of the following companies:
- Make sure your credit history is correct. If you are in debt, set up a plan to pay it off.
- Begin establishing a good credit history by following one or more of the following steps:
- Create a bill payment schedule
- Avoid maxing out your credit cards
- Try to pay off your credit card every month
- Maintain a healthy checking and savings account
- Start with a secured credit card
- Obtain an unsecured credit card, and use it wisely
- Utilize alternative forms of credit, such as store credit lines
- Stay on the path to good credit by avoiding common credit pitfalls, including:
- Errors and mistakes on your credit report
- Unmanageable debt
- Loan default