I had been a student at Georgetown University for only a few months when I got my first credit card. The card even had a picture of one of the campus’ most well-known buildings. Why not get a card to which the university had seemingly given its stamp of approval? And how could I resist the free T-shirt the card company gave me as a reward for applying?
I was 18 at the time, and I did not consult with my parents before applying for the card. I didn’t have to. But that’s no longer the case, thanks to the CARD Act, which President Obama signed into law last year.
The new law prohibits card companies from offering gifts to lure students to sign up for a card on campus or within 1,000 feet of a campus. It also stipulates that those under 21 cannot get a card unless they show proof they have the income to pay the debt or they enlist an adult co-signer.
There’s good reason for this new law. According to a 2009 survey by student lender Sallie Mae, 84% of college students had at least one credit card, up from 76% in 2004. On average, they had $3,173 in debt, a 46% increase over the 2004 figure of $2,169. Only 17% paid off their entire balance each month and 1% had parents or other family members pay it off for them. The remaining 82% carried balances and paid finance charges.
Even though the law makes it very difficult for students to get credit cards, however, that’s still not impossible. The “sufficient income” clause that’s part of the law, for example, allows issuers to forego the co-signer requirement if the student provides proof of “sufficient income.” How much is considered “sufficient” is open to interpretation.
Some issuers may just want to know that your monthly income is more than your minimum payment due. But that doesn’t mean that you can really afford that credit card, does it?
“If you are struggling to pay for your own food, housing, transportation and education bills, you can’t afford to carry a balance on a credit card,” says Bill Hardekopf, chief executive of LowCards.com and author of The Credit Card Guidebook.
Another pitfall: many parents do not fully understand the responsibility (and personal liability) that comes with co-signing a credit card for your college kid.
And while college is a good time for young people to learn about credit, many students clearly arrive on campus unprepared to use credit properly, Hardekopf says.
What can you do? Use this new law as a teachable moment. “Tell your student how to deal with credit cards and the pitfalls that exist,” Hardekopf says. “Explain how to read the monthly bill and how important it is to pay the balance in full at the end of each month. Give them real-life examples of the credit card mistakes you have made so they can avoid making the same mistakes.”
Now, more than ever, the onus is on parents to make sure their children make wise financial decisions. If you’re a parent trying to figure out whether or not to help your child get a credit card, here are a few of your options:
1. Become an adult co-signer.
Your child applies for the card but you are the adult co-signer. If your child can’t pay off the balance, you will be responsible for it. If you or your child pay off the balance on time, it will be good for both your credit histories. But if either of you makes a late payment (or any other action considered negative), both your credit histories will be damaged. Your responsibility won’t end until the balance is paid off — and even then you will continue to share responsibility for any new charges your child puts on that card.
2. Make your child an authorized user on your card.
This could be a good way to teach your child about credit without giving him or her the full responsibility for it. It works like this: You add your child to your account as an authorized user. He or she receives a card with his or her name on it. But you are responsible for paying off the balance — including the charges made by your child. Your child’s credit score will benefit from your paying off your balance. If you don’t pay on time, your child’s credit history will be damaged, as well.
If need be, however, this is an easily severed financial relationship. You can remove an authorized user from the account at any time through a letter or phone call. And you can always request that your child be added as an authorized user, but not receive a physical credit card. This way, you will help them build a credit history without enabling them to fall into debt.
3. Have your child open a checking account with a debit card.
This way, your child is only spending money he or she has. Debit cards have their own fees as well, but there will be no danger of your child getting into thousands of dollars in debt. It won’t affect anyone’s credit score — but on the flip side, it won’t help your child start to build a credit history, either.
4. Open a prepaid card.
The fees for these cards tend to be higher, but it is an easy way to teach your child about the proper use of plastic. Most of these cards, however, don’t report payment activity to the credit bureaus, so just like with a debit card, your child will not be building a credit history.
With any of these options, sit down with your child to help him or her compare all the terms and conditions. Young adults shouldn’t have to make this decision alone.
Nancy Trejos is the personal finance columnist at the Washington Post and the author of Hot (broke) Messes, a personal-finance book for young adults. This week, Mint.com is giving away five copies of Hot (broke) Messes. For participation instructions, click here.