Credit Cards 101: Finding the Right Plastic

For a college student, finding the best starter credit card is an education in itself

by Lauren Young

Related Items



The dreaded freshman 15, those extra pounds that come from eating all those carbs in the school cafeteria, isn't the only thing your kids need to worry about when heading off to college this fall. Sudden access to easy credit could get them into a heap of financial trouble. The National Foundation for Credit Counseling reports that nearly one-half of college students saddle themselves with more than $3,000 of credit-card debt by the time they graduate.

Chances are students will be inundated with credit-card offers from the moment they set foot on campus. Unfortunately, Personal Finance 101 isn't part of the college curriculum. Here's a guide to help college students identify the best and worst credit cards.

The smartest move for newbies to the world of plastic is to find a credit card with no annual fees and a low interest rate. But chances are you won't find them amid the free water bottles, T-shirts, and other giveaways lenders are offering up at school. "A lot of the companies setting up booths on college campuses or mailing stuff to kids are not offering the best cards for students," says Greg Daugherty, executive editor at Consumer Reports. "Many of them are mediocre."

Big Names Get Low Marks

According to Consumer Reports' latest ratings of credit cards, some of the largest credit-card issuers, including JPMorgan Chase (JPM), Bank of America (BAC), Citibank (C), and Capital One (COF), do not get high marks from customers. Readers who use those banks' cards complained that they were assessed unfair late fees or experienced unexpected interest-rate increases. These banks, incidentally, are also big players in the student credit-card market. By contrast, top-rated issuers by Consumer Reports keep rates low, fees to a minimum, and offer stellar customer service.

And that's exactly what students should be looking for when they are shopping for credit cards. To find the best credit cards for students, start your search online. Bankrate.com, LowCards.com, and CreditCards.com all feature sections on student credit cards with information on the best deals. If you are in the market for a card, make sure you check these sites often since interest rates change frequently.

Another good option for would-be cardholders is to keep walking past the tables loaded with freebies and into the credit union, assuming there is one on campus. While credit union membership at colleges used to be limited to employees, the requirements for joining are much looser than they used to be. At some schools, such as the University of Southern California, these financial institutions open their doors to students and offer credit cards to students, among the other financial products. "Credit unions are much easier to deal with if you have problems, and they are much less likely to jerk you around on interest rates," Daugherty says.

Pay Attention to the Fine Print

If a credit union on campus can't serve students, —chances are another credit union can,— says Pat Keefe, vice-president of communications at the Credit Union National Assn. Check with family members to see if they have an affiliation with a credit union.

Before you sign up for any credit card, pay careful attention to the rules of the credit-card game. Although students should get into the habit of paying off their balances each month, chances are they won't. Doing your research ahead of time could save you hundreds of dollars because interest rates on student cards can vary widely. The annual percentage rate is 10% on a Sovereign Bank Student Mastercard while it is upwards of 18% on the Chase Student Flexible Rewards Card.

To the uninitiated, these may just be numbers with little significance, but by playing around with credit-card calculators on bankrate.com, you can see the impact of higher rates on an account with $1,000 balance. To pay off the Sovereign card over the course of a year, you'll pay $87.92 each month at 10%. To pay off the Chase Card at 18%, it will currently cost $91.68.

Avoid the Temptation of Rewards

In addition, experts say students wading into the credit waters for the first time should look for a card with a low limit—$500 worth of credit should suffice until they demonstrate a responsible track record using their plastic. And, as tempting as free airline tickets or other perks may be, they usually don't justify the high interest rates that accompany rewards cards. "A lot of people get tempted by rewards cards because they think it will cover the bill when they are traveling home," says Gail Cunningham, vice-president of business relations for the Consumer Credit Counseling Service of Greater Dallas. You are usually better off paying for it out of pocket, she adds, especially since it is hard to redeem those miles when you want to use them to take a trip during spring break in a sunny climate.

Keep in mind that a credit card isn't the equivalent of an ATM card, so it should not be used for cash advances, except in an emergency. "This may be an easy way to get cash in a crunch, but it is extremely expensive," says Bill Hardekopf, chief executive officer of LowCards.com. "The rate is between 20% and 25%, and the fee is 3%. If you don't pay attention, this can put you over your credit limit, which will generate (an additional) $39 fee and can cause problems on your credit report."

To learn more about managing debt, check out Whatsmyscore.org, a new Web site geared to the college set. It teaches college students all about credit—how to get it, how to use it, how not to abuse it. More advanced students of life can get advice on credit reports and scores. So they should party on. But, whenever possible, have them pay with cash.

Young is a department editor at BusinessWeek, covering all aspects of personal finance. With Sonal Rupani in New York.

Fixing the College Credit-Card Mess

Here are five important measures that could help prevent college students from building up crippling credit-card debt

by Jessica Silver-Greenberg

This story is the fourth in a series examining the increasing use of credit cards by college students.

Every year for the past six years, Representative Louise Slaughter (D-N.Y.) has introduced a bill designed to prevent students from taking on unmanageable amounts of credit. For six years, she has tried to alert Congress to the dangers of college student debt. And for six years, she has failed.

But this year may be different. With a Democrat majority in Congress and a growing number of college kids piling up debt that could haunt them long after college, credit-card companies are coming under increasing scrutiny, and Slaughter thinks she just might have the critical mass to succeed this time. "This Congress finally cares more about the interests of students than the interests of credit-card companies," says Slaughter.

House Bill Would Restrict Credit

Her bill, the Student Credit Card Protection Act, first introduced in October, 1999, with co-sponsor Representative John Duncan (R-Tenn.) and reintroduced this August, would limit the amount of credit extended to students to 20% of their total income if they have a co-signer, like a parent, or $500 without a co-signer. It would also require creditors to rigorously review a student's credit history and proof of income before issuing a card. A companion bill, sponsored by Senator Herb Kohl (D-Wis.) and Senator Richard Durbin (D-Ill.) is pending in the Senate.

If they pass this year, these bills would mark a significant step forward in the battle against dangerous credit-card practices and would work to reform an industry that critics argue is in need of supervision. "No industry in America is more deserving of oversight by Congress," says Travis Plunkett, legislative director for the Consumer Federation of America.

Slaughter's move is just one example of how Congress is turning up the heat on credit-card companies. Senator Christopher Dodd (D-Conn.) held hearings before the Senate Committee on Banking, Housing & Urban Affairs, followed by an extensive examination of credit-card rates and fees, lead by Senator Carl Levin (D-Mich.). Any federal regulation setting caps on interest rates, late payments, or access to college students would be a marked change, since there is virtually no regulation now. "Federal regulators have been asleep at the wheel," says Plunkett.

Of course, even now, this may be nothing more than political sound and fury, signifying nothing. Slaughter and the Democrats may falter in their reform efforts, push for other priorities in Congress, or pass symbolic legislation with no real substance to it. They may settle for congressional hearings that win them positive press and then do nothing, while accepting the plentiful political contributions from card issuers. The top three campaign contributors from the credit-card industry—Citigroup (C), JPMorgan Chase (JPM), and Bank of America (BAC)—gave more than $2 million each in the 2006 election cycle, with roughly equal amounts going to Democrats and Republicans.

Legislating the No-Fly Zone

Credit-card companies, according to consumer advocates, have operated since the early 1980s in a legislative no-fly zone, created after a series of Supreme Court decisions divested states of their ability to protect consumers by setting caps on interest rates and fees. Now credit-card companies can export high interest rates from the states where they are located into the states where consumers live, even if those states have restrictions on interest rates or late fees.

That's why if you look on the back of your credit-card statement, you will see that the return address is most likely South Dakota or Delaware—states considered safe harbors for credit-card companies because they have no cap on interest rates or late payments. "This used to been an arena where the states took a lead, and their ability to do that has been wiped out. Congress has not stepped in to fill that void," explains Tamara Draut, director of the Economic Opportunity Program at Demos, a public policy think tank based in New York.

A few key legislative and regulatory steps could help fill that void. Here are a few practical steps that would curb abuses and help college students and other consumers.

1. Protect students by limiting the amount of credit extended.

No one wants to take credit cards out of the hands of students or to stop credit-card companies from offering students valuable services. Credit in manageable amounts can be a wonderful thing for college students, allowing them to build credit histories and learn to manage money.

But turn credit into a tool, rather than a weapon. As countless students can attest, too much credit can be devastating. Some college kids have access to $10,000 credit lines, with no job and no parent co-signing for the card. That, too often, has proven an invitation to trouble.

Credit-card companies need to extend credit in some rational proportion to a student's ability to pay. One can quibble with Slaughter's proposal to limit credit lines to $500; perhaps $1,000 or $2,000 is more reasonable. But her bill is a step in the right direction.

Yes, ultimately, it is students who need to take responsibility for their own actions, including their credit-card spending. And yes, government officials should be reluctant to interfere with how companies do business, especially when there is plentiful competition. But it's clear that extending enormous credit lines to college kids with nominal income is leading to substantial problems. Credit limits appropriate to students' means will help them make more responsible decisions, allowing them to learn and make mistakes without devastating consequences.

2. Bring more clarity to credit-card contracts.

There are plenty of competitors in the credit-card industry, and that's led to many innovations that have helped the industry thrive. But for consumers to make logical choices among cards, competition also requires clarity. With current credit-card contracts and terms, it's almost impossible to make logical, informed choices, because so many of the conditions are dressed up to dazzle, and the important fees and charges are hidden away in the legalese. Credit-card companies should make key metrics such as minimum payments clearer, building on the clarity gained after reforms that led to what's known as the Schumer Box, which clearly displays basic information like annual fees.

College students have been particularly vulnerable. They often don't realize just how long and how expensive credit-card payments become when only minimum payments are made. If a student pays only the minimum on a $5,800 balance at 27.99% APR, it will take longer than 27 years to pay it off. A bill introduced by Representative David Price (D-N.C.), H.R. 1510, would require credit-card companies to include a minimum payment warning in every billing statement. The warning, which would improve on the Schumer Box disclosures, would tell consumers how many years it would take to pay off their balance with only minimum payments, even if they never used the card again.

3. Require schools to disclose lucrative contracts.

There's another area that requires greater clarity. Universities and colleges nationwide are striking multimillion-dollar affinity contracts with credit-card companies, in which they jointly market cards to students, alumni, and staff. The deals provide money to the schools in return for handing over marketing privileges, student information for direct mailings, and premier marketing locations at football games and the like to the credit-card companies. Schools are making millions of dollars through these deals, with some schools earning nearly $20 million dollars. Yet students and the general public know very little about them (BusinessWeek.com, 9/6/07).

With so much money at stake, there needs to be far greater transparency. Students, alumni, and others should be able to find out the specifics of the contracts—how much money the school makes per year and what the credit-card company gets in return. Often, schools get a bounty for each student who signs up for a card and they get more money the more the student is charged for interest on debts. State legislatures can ensure greater transparency by requiring that schools funded with taxpayer dollars disclose the key terms of their contracts with card companies. They should to let the public know the overall money in the contract, how much the school makes for each student who signs up, and whether the school gets additional money for balances carried on the cards. Schools should also disclose how the profits generated through the contracts will actually be used.

4. Eliminate the most egregious practices.

Credit-card companies have all sorts of ways to zap college students and others with extra charges and fees. Typically these are levied with impenetrable explanations that leave customers scratching their heads about how to avoid them in the future. Congress and regulators should take aim at the most egregious of these practices.

Start with what's known as "double-cycle" billing. The practice, which any bank executive would struggle to justify with a straight face, works like this: Imagine that a student bought a $1,000 laptop for school in August, and received a credit-card bill on Sept. 1, for the entire $1,000 amount, due Sept. 15. If the student pays $800 of that debt by Sept. 15, the student will receive a bill in October that includes interest not only on the outstanding $200 dollars, but for interest on the entire $1000 amount—even the debt that was paid. This alchemy generates interest from debts that never existed. A comprehensive bill, introduced last spring by Senator Levin, would eliminate double-cycle billing.

Another practice that Levin and other politicians have taken aim at is called "universal default." It too deserves to be banned. Under universal default, a consumer who has two credit cards and never misses a payment on one card but fails to pay the other card on time can see the interest rates charged on both cards rise. During congressional hearings, Citibank pledged to discontinue this practice, and has. However, a May, 2007, credit-card survey by the advocacy group Consumer Action found that 8 in 10 banks still practice universal default, despite public statements to the contrary.

Then there are the fees for what's known as "pay to pay." Conscientious students trying to pay off their debt are often penalized for making payments over the phone. In some instances, they are charged up to $5 just for transmitting a payment by phone. Representative Gary Ackerman (D-N.Y.) introduced a bill that would ban any fees imposed for on-time payments by phone.

Clearly, credit-card companies need to make a profit—and well they should for the valuable services they provide. But card companies make money in numerous ways, from vendors as well as from customers, and credit cards have become the most profitable arm of the banking industry. One reason is the explosion in money they've brought in from special fees and charges. R.K. Hammer, a research and advisory firm, estimates that banks pulled in $17.1 billion from credit-card penalty fees in 2006, a tenfold increase from 10 years earlier. Restrictions should be put on the most exploitative practices, to institute basic fairness, not snuff out profits.

5. Keep students informed.

Credit-card companies have wide latitude to raise the interest rates and fees they charge college students and other customers. One common clause in their contracts is known as "any time for any reason, including no reason." Give all that control, card companies at minimum should be required to notify customers clearly when they are changing rates and fees.

If a credit-card company plans to raise the interest rate it's going to charge a student, the company should be required to send the student a letter clearly explaining the change and giving the student the opportunity to pay off the balance. The note should also explain why the interest rate is being raised. Typically now, credit card companies bury a brief and confusing note about the change in the student's next bill. Information is the lifeblood of a market economy. But clear information is too often lacking in card company practices.

Legislation is just one piece of the complex puzzle of student credit-card debt. Students are bombarded with offers of credit, besieged by marketers on their campuses and at their football games. Ryan Rhodes gave us a quick look at some of the credit-card companies' creative tactics in hooking students: Proffering free T-shirts, bike rides, coupons, and sometimes iPods, credit-card companies are creatively marketing (BusinessWeek.com, 9/5/07) to more than a thousand campuses across the country.

So students like Seth Woodworth (BusinessWeek.com, 9/4/07), who after two years is still struggling to get out of debt and get back into school, are graduating with credit cards in hand and crippling debt that could potentially harm their chances of getting a good job or an apartment. And while the debt is piling on, so is the pressure on credit-card companies to do something about the problem. Irene Leech, an associate professor at Virginia Tech, decided to take matters into her own hands, raising pointed questions about the affinity contract between Virginia Tech and Chase.

There are many potential solutions. Some advocates suggest more financial literacy programs in high school and required personal finance courses in college. Others think universities and colleges should take a more active role in limiting marketing to college kids. And plenty of activists say that it's high time that elected officials and regulators take steps to address the issue of credit cards on campus, especially as the problems of indebted students grow every year. "Reform should have happened yesterday," says Plunkett, of the Consumer Federation of America.

Silver-Greenberg is a reporter for BusinessWeek.com.