3 Student Credit Card Traps You Need To Know
The following is a guest post by Mike Dolen of CreditCardForum.
The banks like to tell you that student credit cards are a great way to build credit, which they can be if used properly. But did you also know that they can negatively impact your credit score… even if you pay off your balance in full every month? This fact and others are not common knowledge among college students.
As the founder of Credit Card Forum, I read stories from students every day on our message board and blog. From my experience, these are the three biggest credit card traps that students aren’t aware of…
Trap #1: Using too much of your limit will hurt your credit
Many people (not just students) assume that the more of their credit limit they use, the better it is for their credit score. Nothing could be further from the truth.
A portion of your FICO score is based on credit utilization (what percentage of your credit limit you are using). A high percentage is actually bad. Why? Because it makes you look over-extended (as if you are reaching the end of your rope and therefore, are a higher risk). In turn, the FICO algorithm actually penalizes you for having a high balance. The exact FICO formula is secret but what we do know is that credit utilization, combined with a few related components, make up a total of 30% of your score… so a pretty big chunk!
Myself, as well as most people in this industry, agree it’s best to never use more than 20% to 30% of your credit card’s spending limit at any given time (some even recommend staying below 10%). So if you have a $500 limit, that would mean never spending above $100 in order to stay at 20% utilization.
If you chose to ignore credit utilization, your FICO score will be affected. And if you have a lower FICO score, that might mean you end up paying higher rates when you apply for student loans and college loans. So play it safe – never use more than 20% of your credit limit if you have a credit card.
Trap #2: Interest begins accruing the day of purchase
This is another trap that even many older adults aren’t aware of, so it should come as no surprise that most students don’t know about it either.
When your billing cycle closes, you have a “grace period” of at least 21 days to pay the bill. If you pay the entire balance before the grace period ends, you will not be charged any interest. But if you only pay part of the balance, you will be hit with interest charges for that billing cycle going back all the way to the date of your purchases.
This is why carrying any amount of balance – even if just for a few days – is going to cost you an arm and leg. To avoid this (and the temptation of overspending) I often recommend the AmEx Zync card instead of a credit card for students. The Zync Card is a new charge card (not a credit card) geared towards the 18-25 crowd. It requires payment of charges in full every month, so there is no temptation to get yourself into debt.
Trap #3: Don’t pay $30 for that $12 pizza from freshman year
Okay, so we all know credit card debt can easily snowball, but let me just give you one example of how rapidly this happens…
Let’s say you had a $1,500 balance on your card at a 23% APR (which unfortunately is average for a student credit card). If you only made the minimum payment each month, it would take you 163 months to pay it off and during that time you will have paid an extra $2,220.81 on interest! So if you bought that $12 pizza on day one of having your credit card, it will have cost you about $30 when all is said and done.
Conclusion?
If used properly, credit cards can be one way to help build credit. However there are so many traps and pitfalls, you absolutely need to be disciplined when using them. If you don’t think you have the self-control, then it would actually be best to avoid them altogether.
About The Author: Mike Dolen is founder and CEO of CreditCardForum, which is a consumer portal for credit card reviews. He actually started this message board while he was in college himself. He knows firsthand how quickly credit card debt snowballs, because he was in a bad car accident at the age of 18 and had to use credit cards to pay for many of the resulting medical bills.
