Student Financial Literacy Guide: How Credit Cards Work
When you use a credit card, the bank pays the vendor or merchant on your behalf. The bank is relying on you to pay it back with interest.
When you first get a credit card, your available credit will likely be very low. But over time, as you prove yourself to be responsible and reliable about paying your credit card bill, banks will typically make more credit available to you in addition to more cardholder perks and advantages.
However, just because a bank offers you a credit card or increases your credit limit doesn’t mean that you can actually afford to charge your card up to the maximum. If you are late with payments or run your cards up to the limit, your credit score will suffer.
Why College Students Should Have a Credit Card
Building your credit
While incurring consumer debt on a student’s income is risky, credit cards allow college students to build a credit history, which can help make life after college easier and more affordable. According to the 2016 Financial Services report from Student Monitor, students with a credit card in their own name report having credit scores that are 50 points higher on average (679) than students who don’t have their own credit card (629).
Getting your first job
According to the Society for Human Resource Management, nearly half of employers surveyed conduct background credit checks on potential hires. However, 11 states thus far have restricted or prohibited employers from using credit background checks in the hiring process.
In most states, insurance companies review credit reports when determining whether to issue an auto insurance policy. For example, according to Consumer Reports, single drivers who had merely ‘good scores’ paid between $68 and $526 more in car insurance premiums each year than those with excellent scores.
Getting an apartment
A good credit score can also help you get approved for an apartment or qualify for a lower deposit. According to TransUnion, one of the three major consumer credit bureaus in the United States, 43 percent of landlords run credit checks on applicants as part of their screening process, and 48 percent consider an applicant’s credit report to be one of the top three factors they look at when it comes to apartment leasing applications.
An established credit history can also help you qualify for a lower deposit requirement, or no deposit requirement, when turning on gas, electric and other utilities.
Banks offer a variety of rewards programs designed to encourage you to use your card. For example, some cards offer cash back on purchases every month. Others offer points or miles for every dollar you spend on the card, which may be redeemable for cash, merchandise, travel and more.
Nearly all credit cards come with a number of basic benefits and privileges for cardholders. These benefits commonly include the following perks:
- Free FICO credit score with your monthly statement
- Extended warranty protection on items bought with the card
- Roadside assistance
- Limited/zero liability for fraudulent transactions
- Travel insurance
- Free or discounted collision insurance on rental cars
- Extended warranty and return protection
Additionally, some issuers are providing access to quality financial education developed specifically for first-time credit card users. JPMorgan Chase, Discover and Capital Onehave each expanded their personal finance education sections on their sites to help educate younger customers. This is a particularly important feature, says Beverly Harzog, author of “The Debt Escape Plan: How to Free Yourself From Credit Card Balances, Boost Your Credit Score, and Live Debt-Free” and “Confessions of a Credit Junkie.” “Not everybody’s parents are going to tell their kids this stuff at home,” she says.
Protecting against fraud and theft
Both credit and debit cards help to minimize the need for students to carry cash, which itself is a security benefit. Additionally, if your card is stolen and you are a victim of fraud, your liability is limited to $50 under the Fair Credit Billing Act, as long as you report the fraud or theft within two days of discovery. Liability is limited to $500 if the cardholder reports the theft or fraudulent activity within 60 days.
In addition to these consumer protections required by federal law, the four major credit card issuers (Visa, MasterCard, American Express and Discover) have implemented a zero liability policy, which is a guarantee that the cardholder will not be held responsible for any fraudulent charges, provided the fraud is reported in a timely manner.
Getting Your First Credit Card
When you apply for a card, the card issuing bank will look at your credit report to see if you are a good risk for that particular card. The issuer purchases your credit report from one or more of the three major U.S. credit bureaus: TransUnion, Equifax or Experian. The issuer will consider:
- Your current credit accounts
- The total amount you owe to various creditors that report to the bureaus, including credit card issuers, utility companies, cellphone and internet carriers, car financing companies and more
- Your payment track record
- Your credit usage ratio: This is the amount you owe, divided by your total available credit. A lower usage ratio is better for your credit score.
- Your credit score
In most cases, the credit score lenders will look at is your FICO score. FICO stands for “Fair, Isaac Corporation,” which is a private company that acts as a credit information clearing house. The three major consumer credit bureaus, TransUnion, Equifax and Experian, all get data from FICO, which also developed the algorithm that credit bureaus use to generate your credit score.
Your FICO score represents the likelihood that you will pay your debts on time. Scores range from 300 to 850, with a higher number indicating a better score. While there are other credit scores available to consumers, the FICO score is used by most lenders.
Your FICO score is based on the following factors:
- Payment history: 35 percent
- Debt: 30 percent
- Length of credit history: 15 percent
- New credit and inquiries: 10 percent
- Credit mix: 10 percent
If your application, income and credit history meet the bank’s issuing criteria, which is usually relatively lax for student credit cards, then your application is approved and you will receive a new credit card in the mail in seven to 14 days, typically. According to Student Monitor, the average credit limit for all college students is $1,315 as of spring 2016.
When you use the card, the bank pays the merchant or vendor, and the bank then sends you a bill at the end of the monthly billing cycle. You are responsible for making at least the minimum payment due by the due date on the bill, which by law must be not less than 21 days from the date the bill is mailed. These 21 days are the interest-free grace period for purchases, so if you pay off all your purchases for that month by the due date on the bill, you won’t face any interest charges on these purchases.
Credit cards for people younger than 21
The Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009restricts the ability of banks to issue credit cards to individuals younger than 21. However, you can still qualify for a credit card if you’re younger than 21 if you can demonstrate the ability to repay credit card debts. Be prepared to provide written proof of income. You’ll probably also need to have established some credit history already, such as making student loan payments, rent, phone bills or utilities on time. Those younger than 21 must either apply online or through the mail.
Become an authorized user
You may be able to get a card issued on your parents’ or guardians’ account if they add you as an authorized user. The bank will issue your own card on the primary cardholder’s account if they request it, but you and your parents will be jointly responsible for paying off all charges. This means if you don’t pay, your parents or guardians will be legally responsible for making good on the debt. Most major credit card issuing banks will add an authorized user even if the user is younger than 18. The account holder may have to pay a fee to add an authorized user.
You may also consider asking a parent or other responsible individual to cosign for your credit card by taking responsibility for the charges if you don’t repay them. If the borrower doesn’t pay back the loan or pay the bill on time, or defaults, both parties’ credit reports will take a hit. If the borrower defaults, the cosigner must pay or potentially face the same collection actions as the borrower, including lawsuits, judgments, garnishments, and levies.
Some card issuers, including American Express, do not accept cosigners for credit cards.
Understanding Your Card Features
Your credit card issuer will mail or email you a bill every month. You can also view your bill online at any time by creating an online account and logging into your card issuer’s website.
Here are the most important things you should understand about your bill:
- Total balance: This is the total amount you owe at the time the statement is issued.
- Activity summary: This summarizes the charges and credits to your account during the month. Here you’ll find the aggregate totals of all of the payments, credits, purchases, interest charges, fees, balance transfers and cash advances for the date range on the billing cycle.
- APR: Your annual percentage rate is the interest you pay to borrow money from the credit card issuer. Purchases, cash advances and balance transfers may each have a different APR.
- Minimum payment due: This is the lowest payment you can send to keep the account current and avoid a delinquency on your credit report. You need to pay this to avoid a late fee and a penalty APR.
- Payment due date: This is the end of the grace period, or the date by which the bank must receive your payment by in order stay current and avoid any interest charges on the balance.
- Credit line: This is your overall credit limit or the maximum you are authorized to charge to your card.
- Credit available: This is how much credit you have left before you hit your borrowing limit.
- Rewards: This section will tell you how much you have earned in rewards, whether as cash back on purchases or in the form of points or miles.
- Your FICO score: It is common for student credit card issuers to provide your current credit score from one of the major credit bureaus for free on your statement.