Ways to Build Credit as a Student
Establishing credit while you're in school 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 their age and the length of their credit history.
"The irony of building credit is that you have to show that you can put yourself into debt and then get out of it," says Paul Golden, media relations director at the National Endowment for Financial Education.
If you're not sure where to start, here's an overview.
What Is Credit?
While demonstrating you can use credit responsibly is important, some young people shy away from it altogether, Golden says. "They've seen their parents and older peers 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 bank or credit card issuer lends you, with the agreement you'll pay it back according to certain terms and with any applicable fees. Generally, you'll need to be 18 to apply for a credit card, although the age restriction differs by state. Under the Credit CARD Act of 2009, there's an extra age restriction if you want to apply for a credit card: You'll need either a co-signer or proof you have the income to make payments if you're younger than 21.
[Read: Best Student Credit Cards.]
Once you take out credit, such as a car loan or credit card, the lender will typically 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 managed borrowed money. A higher score indicates you're a lower credit risk.
What Impacts a Credit Score?
It may be tough to earn a high credit score without understanding how you're being graded. Your FICO credit score depends on:
-- Payment history
-- Amounts owed
-- Length of credit history
-- Credit mix
-- New credit
Here's how credit scores are calculated:
Payment history: This has the largest influence on your credit score. Creditors report on-time payments and payments that are more than 30 days late.
Amounts owed: Lenders like to see that you don't have a habit of maxing out your available credit. A good rule of thumb: Aim to keep your credit card balance to 30 percent of the credit limit or less.
Length of credit history: A long credit history shows how you've managed credit over time, and it can positively affect a score. If you've just started using credit, your account history will be brief. Focus on the variables you can control, such as making on-time payments, and your credit history can naturally improve over time.
Credit mix: Having a mix of accounts, such as student loans and credit cards, helps lenders see how you handle different types of credit.
New credit: When you apply for a new line of credit, and it will temporarily ding your credit score. It's best to avoid applying for credit unless you need and can afford it.
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 -- Dlugozima suggests students save $500 to $1,000 -- is 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
-- Become an authorized user
-- 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, according to Experian.
Student loans are treated as installment plans, which means you have set monthly payments over time. The amount of your loans, payment history and amount of your monthly payments will factor in to your credit score. Making on-time payments in full will positively influence your credit.
[Read: Best Starter Credit Cards.]
But if you fall behind, a missed payment could have a widespread impact on your credit. That's because student loans may appear on your credit report as separate accounts for each semester you borrowed money. If you only make one payment to your student loan servicer each month, then one missed payment could affect each account.
Use a credit card. In a 2016 study from Student Monitor, which examines college students' relationship with the financial services industry, 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, in the $200 to $500 range, and a high annual percentage rate, around 25 percent. To qualify for a student credit card, you typically must be a student. But these cards offer plenty of student-friendly incentives such as rewards programs, cash back for getting good grades 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, APR and credit limit, Golden says. Then, set up autopay for your existing bills using your card, such as your cellphone and streaming services, and pay off the bill in full each month.
[Read: Best Secured Credit Cards.]
Become an authorized user. As an authorized user, you can get permission to use someone else's credit card account and benefit from the cardholder's positive account history. Not all card issuers report authorized user accounts to the credit bureaus, so check first. Then, proceed with caution. If the balance gets too high or a payment is late, it may impact your credit as well as the primary cardholder's credit -- regardless of who's to blame.
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. Know your financial weaknesses. For example, Golden says, "if you are prone to impulse spending, then you probably don't want to hang out with people who want to go shopping every weekend."
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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