Establishing credit while you're in college can help make the transition into post-graduation life much easier.
Good credit can help you qualify for lower interest rates on a student loan refinance, pass an employment background check or get approved for an apartment lease. But when it comes to building credit, students' options may be limited due to your age and the length of your credit history. The ironic thing is, the key to building credit is that you have to show you can put yourself into debt and then get out of it.
If you're not sure where to start, we are here to help!
What Is Credit?
While demonstrating you can use credit responsibly is important, some young people shy away from it altogether. They've seen their parents or other people get in trouble with credit, especially with credit card debt. But you can better avoid the pitfalls and enjoy the benefits of good credit by first understanding how it works. Credit is money that a financial institution or credit card issuer lends you, with the agreement you'll pay it back according to certain terms and with any applicable fees.
Once you take out credit, such as a car loan or credit card, the lender will report your account information to the three credit bureaus: TransUnion, Experian, and Equifax. Each bureau captures that information on its own version of a credit report. A credit score, generally on a scale of 300 to 850, is a numerical assessment of how well you've paid lenders in the past. A higher score indicates you're a lower risk for defaulting on your payment.
How Can Students Build Credit?
Before digging in, do a little prep work to support your credit-building, says Chris Dlugozima, education specialist at GreenPath Financial Wellness, a nonprofit credit counseling service. Create a budget, set up an emergency savings account and make sure you have a predictable source of income. "It's like the three legs of a stool, and you want to make sure they're all in place," Dlugozima says.
The budget will help you know how much you can charge to a credit card each month, and the income allows you to pay it off. The emergency fund goal is to have $500 - $1,000 saved to cover unexpected costs outside of your budget.
Once you've laid a good foundation with your budget, savings, and income, you may be ready to start building credit. Here's how:
Borrow only what you can afford
Use student loans to your advantage
Use a credit card
Have rent payments reported to the credit bureaus
Monitor your credit reports
Borrow only what you can afford. While creating your budget, consider whether you plan to take out student loans to pay for school. Although you may be approved to borrow up to your cost of attendance, consider what your post-graduation budget may be when determining how much you can afford to borrow.
Use student loans to your advantage. When handled responsibly, student loans can be a major credit-building tool. Although many student loans don't require payments while you're in school or immediately following graduation, some allow you to make interest-only payments during this period. Making payments while you're in school can reduce your amounts owed later. Student loans are treated as installment plans, which means you have set monthly payments over time. The amount of your loans, payment history and the total amount of your monthly payments will factor into your credit score. Making on-time payments in full will positively influence your credit.
But, if you fall behind, a missed payment could have a widespread impact on your credit. If you took out both federal and private student loans during your college career, it can get confusing for you and may look messy on your credit report. You also may be more apt to miss a payment, simply because your various loans have different payment due dates and payment amounts. It may be helpful to use a Direct Consolidation Loan for your federal student loans so that you will only have one monthly payment to make.
Use a credit card. In 2016, a study of college students' relationship with the financial services industry found that students with a credit card in their own name reported having a higher mean credit score than students who didn't have one – a score of 679 compared with 629. Student credit cards work just like traditional credit cards, but they typically have a low initial credit limit. But these cards offer plenty of student-friendly incentives such as rewards programs, and no annual fees.
If you don't qualify for an unsecured student credit card, a secured card may be a good option. Secured cards are typically geared toward people who are rebuilding credit or starting from scratch. If you're approved for one of these cards, you'll provide a refundable security deposit that typically becomes your credit line. This deposit isn't used to pay your bill each statement period but acts as collateral to protect the lender in case you default on a payment.
Tying up funds in the security deposit may not be ideal for a low-income college student. But as you show responsible credit use, the card issuer may review your account and upgrade it to an unsecured account, returning your security deposit.
Make sure you know your card's due date, Annual Percentage Rate (APR) and credit limit. Then, set up autopay for your existing bills using your card, such as your cell phone and streaming services, and pay off the bill in full each month.
Have rent payments reported to the credit bureaus. Services such as RentTrack and PayYourRent.com can accept your rent payments and report the activity to the credit bureaus. Be sure the lease is in your name and you're making on-time payments each month. But keep in mind not every scoring model uses the rent payment information. Your rental property manager may need to sign up for the service, and transaction fees may apply.
Monitor your credit reports. Stay on top of your credit by checking it regularly. At AnnualCreditReport.com, you can request a free copy of your credit report from each bureau once a year. Your credit card might also offer a credit monitoring program that allows you to check your report and score anytime. When reviewing your reports, check for errors. For example, your report might contain information about someone else entirely, closed accounts reported as open, a payment that was incorrectly marked as late or accounts that appear multiple times. If you find errors, report them to the creditor that provided the information and the credit bureau. You can follow the Consumer Financial Protection Bureau's guide on filing disputes if you need extra help.
Building Good Credit as a Student
While building credit, you'll start to understand how you manage money and where you encounter obstacles. Establishing good credit habits now will go a long way toward saving money when you're financially independent. By understanding how credit works, using credit cards, getting rent reported to the bureaus and showing financial discipline, you can ace money management when you make it to the real world.
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Sources: Greenpath Financial Wellness
U.S News and World Report