Credit 101: A Lesson For College Students

Nearly 64.8% of students have some form of credit card debt. However, it is worth investing in credit for future expenses. This article will guide you through the basics of credit and credit cards and teach you how to be a responsible credit user.

What is credit? 

Let’s start with the basics. Credit is a contractual agreement between lender and borrower where the borrower receives money from the lender with the knowledge that they will pay back the money at a later date.

There are multiple types of credit, but the two most common are installment and revolving.

Installment credit is a loan for a set amount of money that you as the borrower agree to make monthly payments on with a fixed end date. Examples of installment credit include auto loans, student loans and mortgages.

Revolving credit is a line of credit where you can borrow money repeatedly up to a predetermined limit and pay the money off with no set end date. The most common example of revolving credit is a credit card. As a college student, this type of credit is your introduction into building credit.

Having both installment and revolving credit shows lenders that you can manage and pay off debts, and it improves your credit score. It’s important to have both types of credit, but if you are just starting out, you don’t need to worry about installment credit at this moment.

Why you need credit

Now that you know what credit is, it’s time to determine why you need it. If you signed a lease for an apartment, you’ve probably already experienced a situation where you need credit. Having good credit is important to make larger investments such as buying a house or car. Landlords, prospective employers, insurance companies and utility companies often check your credit to gauge your trustworthiness and ability to pay off debt in a timely manner. Thus, it’s not only important to have credit, it’s also important to use your credit wisely.

What is a credit score? 

A credit score represents the likelihood that you will pay back your loans on time, and the information is pulled from your credit report. Fair Isaac Corporation (FICO), the most commonly used credit score, is a scale that shows the strength of your credit score and generally ranges from 300-850 with 300 being poor credit and 850 being excellent credit. Your FICO credit score is calculated based on five categories: payment history, amounts owed, length of credit history, credit mix and new credit.

Payment history makes up 35% of your score and let’s lenders know if you pay your bills on time.

Amounts owed make up 30% of your score and represents how much debt you hold in total. To maintain a strong credit score, keep your credit card balance below 30% of the maximum amount you can spend on that line of credit.

Length of credit history makes up 15% of your score and represents how long you’ve had your credit account open. To build a strong credit score, it helps to have credit established for a long period of time, so it’s important to open credit earlier rather than later.

Credit mix makes up 10% of your score and involves having multiple types of credit. This refers to installment and revolving credit. Lenders look favorably on people who have multiple types of credit because that tells them that you can handle a mix of credit. However, it’s not necessary to have both installment and revolving credit to develop a strong credit score.

New credit makes up 10% of your score, and you should not open too many credit accounts in a short period of time. Having too many new lines of credit signals to lenders that you are a risky borrower who takes on a lot of debt.

How to use a credit card responsibly

Opening a credit card is a good first step toward building credit and planning for your future, but you must be aware and ready to take on the responsibility of maintaining good credit.

Here are some tips for using a credit card responsibly:

Complete your payments on time 

Paying your bills on time makes up 35% of your credit score and failing to do so could detrimentally impact your ability to invest in larger purchases. Late payments will also rack up interest fees and you’ll end up paying even more money.

To combat this, set reminders on your phone or set up automatic payments so you never miss the deadline to pay.

Pay more than the minimum amount on your card

Plan ahead and make sure you have money available to pay for more than the minimum balance on your card. Your minimum monthly balance is the lowest amount of money owed that you must pay each month. If you only pay the minimum, you’re still carrying a balance on your account and you could be charged interest on the remaining balance in your account.

To ensure you aren’t racking up interest, budget so you can pay your account balance in full. If you can’t pay your account balance in full each time, set some money aside to pay for a portion of it.

Don’t close lines of credit 

This relates to the length of credit history sector that factors into your credit score. Even if you don’t use a credit card anymore, you should still keep the account open to show longevity and boost your credit score.

Freeze your credit

Freezing your credit prevents consumer credit agencies from selling your credit report information to third parties, and it’s an important step to ensure your identity does not get stolen. When your credit is frozen, new lines of credit cannot be opened in your name. The good thing is that you can unfreeze your credit at any time for a specific period of time.

You can freeze your credit report at any or all of the three credit bureaus: Equifax, TransUnion and Experian.

Now that you understand the basics of credit cards and how to use them responsibly, it’s time to open a new credit card. Be sure to do your own research and figure out which card is best suited for you and your needs.

Happy Spending!