What advice do you give college students about building their credit scores?
First and foremost, you have to understand that it’s part of your life. A lot of borrowers I work with don’t have bad credit. They just don’t know how to play the game. It shouldn’t be called a credit score. It is a debt score. It is a measurement of how well you handle revolving debt. Say you get a credit card with a $5,000 limit. Can you be responsible enough not to charge the entire $5,000?
The credit score is really designed to see how close to the edge you can get without falling off and dying. Just like you give an employer a resume when you’re applying for a job, a credit score is like a resume for lenders — it’s a snapshot. The credit score is based on a secret algorithm. They won’t tell us exactly what it is. But the two most important things are don’t pay late and have credit cards. You do need credit cards — installment loans don’t really help. If you cannot get a credit card, get a secured card. After about six months, you’ll start getting solicitations for unsecured credit cards.
Some experts say college students shouldn’t have credit cards, that they’re just too dangerous. But it sounds like you disagree. Why?
There are benefits and risks to anything. The benefits of learning to use revolving debt far outweigh the risks of having credit cards. Not exclusively college students, but everyone needs to learn how to successfully navigate the credit system that our country runs on. You don’t get in trouble unless you’re irresponsible. You don’t become responsible without being irresponsible first. I know that’s how I learned. We don’t teach finances in school. Kids need to learn that credit cards are not free money, and the best way to do that is to get a credit card, charge it up and then deal with the consequences. I think it’s dangerous to tell people not to do something because they might get into trouble. You should get a credit card but use it only for convenience — buy your snacks, your groceries and your gas, and pay it off at the end of the month. Use the plastic as a debit card essentially, and don’t buy anything that you don’t have cash for.
Speaking of debit cards, does a checking account with a debit card help your credit score?
No. Debit cards do not report to the credit bureaus. It’s not revolving credit; you’re just spending money you’ve already put in the bank.
What’s the biggest mistake you see students make in terms of managing their credit scores?
Peer-to-peer lending is really big with college students. The way that lenders are approaching it is interesting, but I see it biting people in the butt. Credit card interest rates are 25 to 28 percent if you don’t have good credit. Peer-to-peer lending comes in at 10 percent to 15 percent, so people think the interest rates are significantly lower. But people forget that if you pay off your credit card balance, you’re not paying any interest. A peer-to-peer loan commits the borrower to a higher monthly payment, and it’s an installment loan. It’s the same as a car loan in terms of how credit scores are calculated.
Making your payments on time on an installment loan is like a pinch of salt when you’re baking a cake. The other thing I tell people is don’t cancel credit cards. If you get in trouble with a credit card, pay it off, but don’t cancel it. Even if you never use it again, if you wrap it in three inches of duct tape and throw it in the back of the closet, don’t close it. Closing a credit card is very detrimental to your credit score in terms of longevity of credit.
New businesses have popped up to report rent payments to credit bureaus. Should students take advantage of that type of service?
They should be doing anything to proactively build positive credit. If reporting your rent is something you can do, you should do it.
What about putting textbooks on a credit card? Some people warn against it.
There’s a fine line when it comes to managing your liquidity. If you have $300 in the bank and your books are $300, I’d much rather you put that on the credit card, and pay it off over six or 12 months, instead of spending every penny you have. What if something happens?