Acquiring Your First Credit Card
Establishing good credit for young consumers
A frequent topic of discussion is how young consumers can establish and build credit. Building good credit habits is essential because a good credit score can provide benefits beyond favorable rates and larger credit limits. It can also positively impact car insurance rates and can make it easier to rent an apartment, among other benefits.
The Credit Card Accountability Responsibility and Disclosure Act of 2009, or CARD Act, contains numerous consumer protections relating to the rights of credit card holders and those looking to obtain a card or a credit increase on an existing card. There are provisions to protect young consumers under the age of 21 regarding the solicitation and application for credit cards.
Card applicants under the age of 21 must prove that they can independently repay debts associated with the card. This requirement means that applicants must have employment income, and not rely on income from parents or a spouse. The “ability to pay” test is strict; however, there are other options to establish credit for those under the age of 21.
What are your options?
Credit card cosigner
Have a cosigner, which can be anyone over 21 with the means to pass the ability to pay test. The advantage is that the primary borrower can get a more favorable rate and will build a credit history. The disadvantages are that the co-signer is legally responsible for the payments and any missed payments would negatively impact the cosigner’s credit score.
Add a younger applicant as an authorized user on their parent’s card. Most card issuers report authorized users to credit bureaus, which helps establish good credit for the user. This approach is not entirely risk-free. If the primary cardholder doesn’t make timely payments or has a high credit utilization ratio, it can have an adverse impact on the authorized user’s credit history. It is worth noting that the authorized user will have the same card number and full access to the credit line, which may not be desirable.
Secured credit card
Open a secured credit card. This type of card requires a security deposit to establish the account. The advantage is that the entire process and credit history is solely the responsibility of the applicant.
For consumers over age 21, credit card application requirements are more flexible. If an applicant has access to income or assets from a spouse or parents, they could be considered during the application process.
Regardless of the approach taken to establish credit, it is advisable to only use a modest amount of the available credit line. Setting up an automatic payment is recommended to ensure payments are not missed. Ideally, the full balance would be paid monthly; however, it is prudent to set up an automatic payment to ensure the minimum statement balance is covered each month. Missed payments and using the full credit limit can have a negative impact on the credit score.
Another consideration is the type of card to apply for. Reward programs can be advantageous if selected appropriately and used to their full extent. There is a broad range of benefits from cash back to travel rewards, and certain cards accumulate rewards faster than others based on how the card is used in various spending categories. Reward cards can have annual fees, which should be factored into the decision when evaluating what card best suits your needs. No two cards are alike, so the details of each program must be thoroughly reviewed.
Placing a credit freeze with the various credit reporting bureaus (Equifax, Experian, and TransUnion) is a proactive way to minimize the risk of additional cards being applied for in your name. By freezing your credit, potential creditors cannot access your credit report. Should you become a victim of identity theft, it will make it difficult for someone else to take out a card or other liability in your name. It is easy to permanently or temporarily lift the freeze in the future if you need to. Once you are building credit, you can request a free credit report from each credit bureau every 12 months, allowing you to review all of the information on your credit reports to ensure it is correct and up to date.
The CARD Act also prohibits prescreened card offers to consumers under the age of 21 unless they have opted in with the credit reporting agencies. If you are over 21 and do not want to receive these offers, you can opt out at www.optoutprescreen.com.
With careful planning and some patience, while building a credit history, you can establish a good credit score and likely see your credit limit increase in relatively short order.
Senior Client Associate
Brian provides support to Versant Capital Management’s wealth counselors and senior professional staff and help to enhance the quality of the firm’s services.
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