For many teenagers, there's no better feeling than the first time they hold a credit card. The rush from running one's fingers along the raised numbers, as they watch the card shine with each turn, sends tingles up their arms. They think, "Now I can afford everything I've always wanted." Despite such excitement, these newbies need to know how to use a credit card responsibly if they want to set themselves on a path toward a stable financial future.
Teenagers commonly start building credit by having their parents make them an authorized user on their card; other parents co-sign for their child to get their own credit card (minimum age requirements vary by lender). While consumers used to be able to qualify for their own credit card when they turned 18, the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009 requires anyone under 21 to either have a cosigner or verifiable income that proves they have the means to repay the debt.
No matter how their first credit card is obtained, many teenagers make mistakes—some of which have detrimental effects on their financial lives. Janna Herron, credit card analyst at Bankrate.com, says impulsive teenagers are the most likely to abuse credit. "A lot of spontaneous buyers—people who want instant gratification—would get a credit card and buy everything they see simply because they have the means to do so," she says. Such teenagers who immediately spend a paycheck or money they received as a birthday present need to reform their habits before getting a credit card.
Those without controlled spending behavior may confront early blunders with credit, some of which can follow them for decades. "Most people start using credit between 18 and 22 years old, and depend on credit into their seventies," says John Ulzheimer, president of consumer education at SmartCredit.com. "That's a long period of time. When you're building wealth, applying for mortgages, or co-signing for student loans, you're really depending on your credit to finance these necessary purchases."
Consequently, Ulzheimer says it's important to start building credit as early as possible. He says those who wait until they're out of college to get their first credit card won't have good credit to lean on when they go to apply for a car loan or lease an apartment. The higher interest rates some are offered will not only be costly but can complicate whether they can afford to take out a mortgage.
With credit playing an important role in a number of financial determinations, learning good habits at the start can give consumers the edge they need when applying for an auto loan, a mortgage, or even a job. If you're on the verge of becoming a credit card user, here's what you need to know to understand how to use this light, yet powerful, piece of plastic:
Take control of your spending. Before applying for a credit card, create a budget. You can use a website such as Mint.com to track your spending over the course of a month. Take note of what you're spending money on and pinpoint where you can cut costs. If you know where your money is going, you'll have a better idea of how much you should be charging within a given cycle, says Bill Hardekopf, a credit expert with LowCards.com.
Also pull your credit report, which you're entitled to view for free once a year (annualcreditreport.com), to make sure no one has stolen your identity and used your credit for fraudulent purchases.
Figure out what you want. Which credit card is right for you depends on what you're looking for, says Herron. Some applicants want a card with no annual fee, while others are enticed by a sign-up bonus. For some, the decision may come down to small terms, such a card with no foreign transaction fees that sounds enticing to students who plan to study abroad.
While many teenagers decide what card they'll apply for based on the annual percentage rate (APR), Ulzheimer says that shouldn't always be the deciding factor, since people don't know what interest rate they qualify for until after the application is processed. But applying for multiple cards at once will dent your credit score, as each triggers a hard inquiry on your credit. Ulzheimer says the interest rate is only a determining factor if you think there's a strong likelihood you'll carry a balance from month to month—in which case, you're setting yourself up to lose money in exchange for establishing credit. Those confident they can pay off their bill each month may want to look for a good rewards program.
However, cards that offer attractive rewards pose risks, according to Gerri Detweiler, director of consumer education at Credit.com. "I wouldn't focus on rewards for your first card, only because it's so tempting to start using the card for everything and then end up with a balance that you can't pay off," she says.
Live within your means. Typically, a first-timer is given a credit line of $500 to $2,500. While those limits sound high to some, a number of teenagers quickly reach their threshold within a given month—and want to continue using the card before the next billing cycle. Fortunately, the CARD Act offers an added protection for consumers: Only people who enroll in over-limit fees can use more credit than they're allotted. By agreeing to allow over-limit fees—charges (typically ranging from $15 to $40) that are applied with each purchase made after the user has hit their credit limit—cardholders put themselves at risk of losing money.
Nonetheless, a large number of teenagers continue to opt in for over-limit fees. "It's my belief that embarrassment has a price," says Ulzheimer. "It's a pride issue. People don't like being declined, especially in front of a group of their friends." Although no one likes the prospect of seeing their card declined, over-limit fees aren't worth it.
Monitor activity. It's arguably the most basic step to responsibly using a credit card, but many first-timers don't check their card activity—or, at least not as often as they should. To stay on top of things, Detweiler suggests signing up for mobile or email alerts notifying you every time the card is used. Those who prefer to monitor less frequently should check their account every other day, says Ulzheimer, adding it only takes a couple minutes.
Furthermore, a large proportion of the 10 million Americans who fall victim to identity theft each year have their personal information stolen through their credit card usage. Although small purchases won't drastically raise your bills, Hardekopf says both low and high transactions are worth scanning when looking for warning signs of identity theft. "There are countless stories of identity thieves who get your credit card number and start out with a small purchase under $10, just to see if it goes through. Then, when it goes through, they'll buy a bunch of other stuff," he explains.
Pay it off each month. Making the minimum payment doesn't cut it. If you carry a balance, the card quickly becomes your enemy—slapping your remaining debt with a nasty interest rate. Detweiler says it's a bad habit made by many credit card users—not just first-timers. "It's called a minimum payment, but making minimum installments from month to month crushes your finances," she says. She says many consumers don't understand if they carry over an amount, new transactions start accruing interest immediately. In the event you carry a balance, Detweiler recommends holding off on using the card until you can get it paid off; otherwise, "you'll be paying more for everything you buy."
Watch how much credit you're using. While paying off the full balance each billing cycle is crucial, credit card users should try to keep their balance under about 25 percent throughout the month. This will keep your credit utilization ratio—a large factor in how credit scores are calculated—in a healthy range. Detweiler points out this can become an issue for many college students who use their credit card to pay for textbooks. "Using 90 percent of a $1,000 credit line, even if it's to buy books, looks just as bad as using 90 percent of a $10,000 credit line," she says.
The bottom line: Like learning how to ride a bike, tie your shoelaces, or drive a car, Ulzheimer says learning how to use credit takes practice. Still, first-timers can position themselves for success if they go into the process knowing what makes for a responsible credit card user.