Credit 101

Posted by Caitlin on November 11th, 2008

If you are a high school or college student, now is the best time to begin establishing a credit history, and that means that it's also time to learn how to use credit responsibly. You may have one or two credit cards already, or perhaps you're just beginning to consider applying for your first. Either way, it is crucial to be informed about credit before making financial decisions that will impact you for the rest of your life.

Building a credit history may not seem like a priority for you right now, but planning ahead will benefit you immensely in the future. Paradoxically, in order to receive any type of credit, you will nearly always be required to demonstrate a history of using credit responsibly. This means that your credit can determine whether or not you can qualify for a student loan or an auto loan, for example, and if you do receive a loan, your credit will impact your interest rate. Your credit will also determine whether or not you can lease a car, and it may affect your payments. Renting an off-campus apartment will require a credit check. Some utilities, including cell phone plans, require a credit check and if you have poor credit, they may demand a hefty deposit or even refuse service. Sometimes, potential employers check credit reports. Good or excellent credit is required in order to qualify for credit card offers with the best terms and rewards programs.

Your credit report is a record of your payment history for all types of loans and lines of credit. It includes information on whether you pay your bills on time, where you live, and whether you've ever filed for bankruptcy or been sued. If you pay your bills on time every month and stay within your credit limits, you should have a high credit score. If you have defaulted on loans, have a history of late bill payments, or carry a large amount of debt in proportion to your available credit, your score will be lower. To learn more about credit reports and scores, see our FAQ.

Your credit score is similar to your GPA. If you earn very poor grades as a freshman, it will be possible, but more difficult, to raise your GPA when you are a senior. But if you earn good grades during your first few semesters, it will be much easier to maintain a high GPA throughout the rest of your time in school. You can repair poor credit through hard work and diligence, but it is much better to establish a good credit history, and a high credit score, when you are young and have a blank slate.

It is not enough to pay your bills on time and make sure to stay well below the limits on your credit cards. If you are serious about building and maintaining good credit, you should also review your credit report from time to time, and you should keep a close watch on any open credit accounts. This is important because of the risk of identity theft.

Identity theft occurs when a criminal obtains sensitive, personal information such as a credit card number, bank account number, or Social Security number, and uses the stolen data to fraudulently open new accounts in someone else's name. Identity thieves frequently target children, in which case the crime often goes undiscovered for many years, until the victim grows up and attempts to open his or her first credit account only to find that his or her credit has already been destroyed. Living in a dorm at college can also put you at additional risk for identity theft, since more people are likely to have access to your mail, your credit and debit cards, any personal documents you might have, and your computer.

Earlier this year, Rolling Stone published a story about a Drexel student who started out shoplifting but soon moved on to stealing Social Security numbers, driver's license numbers, bank account information and passports from her neighbors and using the pilfered information to open credit cards and bank accounts in other peoples' names. Her boyfriend rigged all the Internet accounts in their building to run through his own computer and installed Spyware on their neighbors' computers. The couple created fake driver's licenses and stole credit and debit cards from their friends at Drexel and the University of Pennsylvania. Their story shows how easy it can be to steal peoples' identities, especially in a college setting.

The best way to detect and prevent identity theft is with an identity theft protection service, which will either set fraud alerts with the credit bureaus to prevent new accounts from being opened in your name without your approval, or simply monitor your credit file and alert you to any changes. To learn more about identity theft protection services, see our reviews and comparison chart.

Another option is to sign up for a credit monitoring service, which will provide you with free copies of your credit report and in some cases, your credit score, and explain what factors are helping or hurting your credit score. A credit monitoring service will also alert you to any chances in your credit file. To learn more about credit monitoring services, see our reviews and comparison chart.

Once you have checked out your credit report to make sure there are no negative or erroneous items that need to be dealt with, you may decide that it's time to apply for your first credit card. There are many credit cards specifically designed for students who have no prior credit history. It is a good idea to begin establishing your credit history with a student credit card, because if you wait until after you have graduated, you may have difficulty qualifying for any credit card offers. The sooner you begin establishing credit, the longer and the better your credit history will be. A few years can make a dramatic difference in your credit score, especially when you are young and your credit report does not yet contain a great deal of information.

There are many other benefits that will come with having your first credit card, in addition to establishing credit and improving your credit score. A credit card is invaluable in case of emergencies. Sometimes, a credit card is required to make reservations at hotels, restaurants, salons, or spas. When shopping, and especially when shopping online, it is much safer to use a credit card than a debit card, because credit cards give you the chance to dispute a charge that you believe to be incorrect. With a debit card, your money will already be gone before you recognize a problem. The ability to dispute a charge can also come in handy in the event of a disagreement with a retailer.

Most credit cards come with a number of other perks. Many offer extended warranties, which means that if you buy something with your credit card and the item breaks after the merchant warranty has expired, your credit card company may still refund the purchase price. There is also retail purchase protection, which will reimburse you up to $500 if a purchase is stolen, destroyed, or accidently broken within the first 90 days. Most credit cards also offer automatic car rental insurance and roadside assistance, and some have a dedicated concierge service to assist cardholders. Certain credit cards give cardholders access to airport lounges or tickets to exclusive events.

When selecting a credit card, it is important to read the terms carefully and to compare a number of credit card offers before making a decision. Some schools allow credit card companies to set up tables on campus, where credit card representatives lure students with t-shirts, candy bars, or other free gifts. You should beware of these attempts to convince you to apply for a credit card without carefully considering the terms. Having several credit cards, especially at a young age, is often a recipe for disaster.

There are many factors to consider when comparing credit card offers. (And a free t-shirt should not be one of them!) The ideal credit card would offer cardholders a low APR, no annual fee, and an excellent rewards program. Realistically, though, it is more likely that you will have to decide which of these criteria are most important to you when considering credit card terms. Other factors to consider are the credit limit and the various fees and finance charges associated with the card. Take your own financial situation into account when comparing offers. Are you likely to carry a balance, or will you pay your credit card bill in full each month? Realistically, will you take advantage of a points or travel miles rewards program, or would you be better off with cash rebates?

NextAdvisor.com's student credit card reviews explain the more significant differences between different credit card offers, and should be helpful in determining what type of card is right for you. And for more information about credit cards plus definitions for many common credit related terms, see our credit card FAQ page.

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