Along with shopping for a mini fridge and extra-long twin sheets
for your college-bound kid, have you stopped to think about what
type of plastic to send along with your child for emergency
expenses?
Having your student open a bank account, complete with their own
debit card, is convenient for necessities and for parents to be
able to transfer funds. But how would your kid cover the cost
of a hard drive meltdown or car transmission explosion?
Few parents hand over their credit card to their college kids to
take with them without some major trepidation -- including, but not
limited to, sudden heart palpitations and shortness of breath --
but alternative solutions do exist.
Here's a look at your four chief options so you and your student
can choose the one that fits as well as those sheets.
1. Secured credit cards
The pros
: The best way to safeguard against any mishaps during the initial
learning stages of money management and financial independence is a
secured card, says Katie Ross, education and development manager
for American Consumer Credit Counseling, a Massachusetts-based debt
counseling company. Those carrying a secured card must add a
security deposit to the card (the minimum is often $200), which
acts as the card's credit limit, so there's no risk a student will
rack up a mountain of debt. Your child can't charge more than the
security deposit. If a student doesn't pay off the card, the
deposit is forfeited.
"If the card issuer reports to any of the three credit bureaus,
this type of card will help the student build a credit history,"
says Ross. Better yet, when searching for a secured card,
find one that says it reports the card activity to all three:
Experian, Equifax and TransUnion.
The cons
: Secured cards are notorious for their fees. "College students
need to be careful about application, activation and other fees
associated with secured cards," says Gail Cunningham, spokeswoman
for the National Foundation for Credit Counseling. In addition to
fees, secured cards have much higher interest rates, so a lesson
with your student on why it's important to pay off a credit card
balance in full every month is in order.
2. Add your kid as an authorized user on your
card
The pros
: Adding your child on your credit card account as an authorized
user is the option preferred by NFCC's Cunningham. "This way the
young adult begins building their own credit history as all
activity is reported in both the parent's and the student's name,
but parents have access to the account to view spending
online."
"As primary account holder, you can cut off the line of credit
immediately if you see your child is using the card
inappropriately," adds Kelley Long, accountant and member of the
American Institute of Certified Public Accountant's National CPA
Financial Literacy Commission.
The cons
: If your authorized user kid racks up a balance on your card that
can't be paid off every month, that will increase your credit
utilization ratio, which can dent your credit score. Plus, you
could be on the hook for paying off a big bill to protect your
credit score. "Card owners are 100 percent responsible for charges
made by authorized users, so parents could face a nasty surprise
when they get their statements," says Long. That arrangement
doesn't necessarily allow authorized users to develop a keen sense
of financial responsibility.
"Even if your intent is to teach budgeting, what your child may
instead learn is that he has free reign to spend without having to
tie that to any type of earning," says Long. A spending
contract should be drawn up between parent and child outlining what
the expectations are, along with consequences for ignoring those
expectations.
3. Co-signing for a card
The pros
: Due to credit restrictions enacted by the Credit CARD Act of
2009, consumers under the age of 21 cannot obtain a credit card on
their own unless they can demonstrate ability to pay (via a steady
job or other verifiable income) or have a co-signer. So parents may
want to step in and co-sign on a card to give their children the
chance to begin establishing credit in their own names.
This option gives students more autonomy than if they were an
authorized user as the bill goes to the student, not the
co-signer.
The cons
: Parents won't have access to the account unless permission is
granted by the student, so mom or dad won't see how much is being
spent on pizza and beer.
Nevertheless, co-signers are financial liable for the account in
the event the primary account holder (your kid) does not pay the
bill. Without control over the account, your kid could rack up big
debt -- with your name all over it.
Cosigning for a credit card also leaves your credit score
exposed. "It isn't a good idea," says Mitchell D. Weiss, economics
and finance professor at the University of Hartford in
Connecticut.
"Your credit score will take a hit if your child misses a
payment or two, or makes payments late," says Ross.
Before signing on the dotted line, consider your child's level
of financial responsibility, maturity and impulse control. "You
also need to consider that since the card is in the student's name,
as the parent you can't cancel it without the student's approval,"
says Cunningham.
To best protect your credit score, Long suggests that you and
your child talk to the card issuer to ask if the credit limit can
be set at an amount that you can easily pay. "That way if your
student isn't able to handle the responsibility of paying on time
and in full each month, you can pay the balance to prevent missed
payments from denting your credit score," she says.
4. College kids getting their own credit card
The pros
If your child is 21 or older, or younger than 21 and can show
proof of income, a card issuer may be willing to give your
college-bound kid his or her very own piece of plastic. Cunningham
says this puts all the risk on the student, who may lack the
emotional maturity to make good financial choices.
This would be a great time to help your child build a credit
score that's worthy of the dean's list by teaching the basic rules
of how credit cards work. "The most important thing for a college
student to learn is what an APR is, how a billing cycle works, why
you should pay more than the minimum payment and to have the
knowledge that the card is a walking loan and is not their money,"
says Chase A. Peckham, a certified personal finance counselor and
educator at DebtWave Credit Counseling of San Diego.
The cons
: In addition to the risk that your college kid will graduate with
a pile of debt or a flunking credit score, he or she could simply
have trouble finding the right card. "There are so many out there
and it's hard for someone with no experience or guidance to know to
look at APRs and to not be lured by flashy rewards," says Long.
This should really only be an option for kids who've already
proven themselves by being authorized users or having secured
cards, says Ross.
No matter which type of plastic you choose, it's important for
parents to check in frequently with their college kids to see how
they are doing with budgeting and spending, especially during that
first year away from home. "This is their first time having to
account and budget their own money," says Long.