Your College Student’s Credit Future

College Students and Credit

Data from 2015 revealed that average college students in the United States graduated with of student loan debt of $30,000. By the following year, 11.2 percent of these loans were either in default or delinquent by more than 90-days. 

How Can Parents Help?

It’s up to parents to teach their students how to use credit responsibly. They can do this by setting clear expectations and by modelling healthy credit and financial behaviour.

Part 1: Personal Finances – Credit Reports and Credit Scores

It’s surprising to learn just how many students know almost nothing about credit reports and have little or no understanding of how their credit history affects their credit score.

Explaining the Difference 

Credit Score: This number indicates how likely a consumer is to repay a loan on time.

Credit Report: This provides an in-depth look at the previous seven to ten years of a person’s credit history.

How Credit Scores Are Calculated

Your credit score is based on your credit history, like your levels of debt, the number of open accounts, your repayment history, and other relevant factors. Your credit score is used to determine the likelihood that you’ll repay your loan in a timely manner. Your credit score is typically driven by the following indicators –

35% – Payment history

30% – Amount of debt

15% – Length of credit history

10% – Credit mix

10% – New accounts

How To Quickly Build Good Credit

Establishing a pattern of good credit behaviours can take a few years, which means that the sooner your student starts building credit, the better. Students can take the following steps to start building credit –

• Open a credit account for your student as soon as possible,
• Use credit every month,
• Diversify your credit accounts,
• Don’t miss payments,
• Don’t max out your credit limits, and
• Don’t apply for multiple credit cards at the same time.

Learn How To Budget

A student who has never learned how to budget is more likely to misuse credit. They will be prone to overspending, then rely on credit to make up the difference.

How to Create an Effective Budget

No. 1: Determine Your Income

Identify regular income that’s consistent every month, then estimate irregular income by averaging your income over the last 3-month period.

No. 2: Track Your Expenses

Online banking tools and your receipts can be used to calculate your spending habits over the past month.

No. 3: Categorize your Expenses

Divide your expenses into ‘fixed’ and ‘variable’. This will help you identify items you have control over, and the ones you don’t. For example: your electric bill probably varies from month to month but it’s still a fixed expense, whereas the money you spend on food is considered a variable cost.

No. 4: Choose a Budget Model

If you’re not an experienced budgeter, keep it simple to begin with. The first few months will give you a fair idea of where your money is going. You’ll need to make adjustments as you go. This process will take time and you must be willing to try again if your budget doesn’t work at the beginning.

Learning About Investing And Retirement

Your Student Should Start Investing Right Now!

Habitual saving is an extremely powerful tool that should be utilized by students as soon as possible. Students should also be aware that saving for retirement allows them to use the power of compound interest, instead of having their debts work against them.

Part 2: Understanding The Proper Use Of Credit

Students and Credit Cards

Credit card companies are notorious at targeting students, knowing they can be impulsive and have relatively little credit card experience. The majority of credit cards for students come with a range of fees and high interest rates. It’s imperative that parents actively help their students by teaching them how to use credit cards properly.

Choosing a Student Credit Card

When choosing a credit card for your student, parents should look for the following qualities –

• Low interest rate,
• Low fees, and
• Low credit limit.

About Student Loans

A whopping 68% of seniors graduate from college with an average student loan debt of more than $30,000. Many students find themselves still saddled with student debt well into their forties – a time when they should be focusing their financial efforts on retirement savings and investment. Parents can play an important role in educating and advising their young people about financial matters and the real future cost of student loans.

Keeping Student Loans as Low as Possible

Additional forms of student finance such as scholarships and grants can ease financial pressure and reduce the subsequent amount of student loans to be repaid later in life. Students can also benefit from taking on a casual job while studying and directing part of their income into the cost of their education. Every dollar directed into their education is one less dollar that needs to be repaid – with interest. 

Choose your Loan Type and Amount Carefully

Students who can become approved for Federal Student Loans will have access to many benefits not afforded to students with private loans. These benefits include lower interest rates, flexible repayment options, and loan deferment options. Students must also be mindful of the amount of their loan. A loan amount that is too low can leave students looking towards higher-interest options like credit cards to fill the gap, while borrowing too much can saddle a student with unnecessarily high debt and can encourage unnecessary spending.

Motor Vehicle Loans

Purchasing a motor vehicle is a difficult undertaking that – if not approached carefully – could have lasting negative consequences for a student. Ideally, every young person will be accompanied by an experienced adult when shopping for a car and taking out a motor vehicle loan. Car salespeople are particularly adept at manipulating inexperienced young people into signing up to purchase expensive cars with high-interest rates. Teach your student to never purchase the first car they see, and to always leave a dealership if they are feeling pressure or notice any heavy sales tactics being used.

A Careful Look at Interest Rates

The best interest rates will usually come from credit unions and large banks. However, these larger institutions are usually wary of offering credit to students, and those that do may charge a higher interest rate. Young people with limited credit history should shop around and compare interest rates before choosing a motor vehicle loan.

Part 3: How To Get Out of Debt

It is remarkably easy to become overwhelmed with debt at any age, and students are unfortunately no exception. While it may be tempting to bail your debt-laden student out by paying their debts for them, your young person won’t learn any lessons this way. Instead, work with the student and help them to make an actionable plan to pay down their debt and live within their means. 

Dealing with a Large Amount of Debt

• First, Create a Skeleton Budget

A skeleton budget is one that eliminates all discretionary spending. It’s a plan to live somewhat frugally while the focus shifts to repaying debt.

• Next, Choose a Debt Repayment Strategy

The three primary debt repayment strategies to choose from are as follows:

• The debt avalanche method involves listing debts in order from the highest interest rate to the lowest, and focusing repayments on the highest-rate debts first.

• The debt snowball method is similar to the avalanche method, but involves listing debts from the smallest to the largest balance. The idea is to repay and close the smallest loan first, then systematically work through the list.

• A student with a high level of credit card debt may benefit from transferring and consolidating their debt into a balance transfer card with a lower interest rate.

• Finally, Increase Your Income

An obvious but often overlooked method of reducing debt is to increase earnings and apply this additional income directly to debt repayment. Consider ways of earning an extra $100 a week, such as taking on additional shifts at your current job, or signing up for a ride-sharing or food delivery service.

Repaying Student Debt

The last thing any graduating student wants is to still be repaying their student loans in their forties. By the time your young adult is ready to purchase their first home or think about retirement savings, their student loans will ideally be long repaid. Encourage your student to prioritise student loan repayments when they are young so that their ability to conduct adult financial decisions won’t be hampered.

Forbearance and Deferment 

Forbearance and deferment are both avenues for students to pause their regular loan repayments for a short time if they are unable to make their repayments. This arrangement can benefit students who face unexpected financial difficulties, such as a job loss or an illness or injury that impacts their ability to earn. 

Students with Federal Student Loans have the benefit of deferment – the ability to pause their repayments for a short time. Students with other types of student loans can apply for forbearance, which allows for a pause on the principal loan repayments for up to twelve months. Interest payments must still be made during this time. 

Federal Student Loans

One of the benefits of a federal student loan is the ability to choose a repayment plan that suits your needs. By default, student loans are set to be repaid within ten years, but this can be changed by choosing a different plan. Graduated plans allow repayment amounts to start small and increase over time. For students looking to make lower repayments, an extended repayment plan can be chosen to increase the term of the loan to twenty-five years.