Ask John: Credit in College

How My Credit Usage In College Impacted Me After Graduation.

Background

Please meet Lawanda, a 22-year-old 3rd year law school student who lives in Atlanta, GA. She graduates soon and already has interned at a local law firm where she hopes to work full time after she graduates.

Wanda’s story (she prefers to be called Wanda) is really one of the more “feel good” stories we’ve heard. She grew up in Atlanta in a small home with 3 brothers and 4 sisters. Her public school was in a very poor area of the city, which is constantly in the local news for drug, violence and gang related incidents.

She never knew her father and her mother were busy working multiple jobs trying to keep a roof over the family’s head and food on the table.

Early on Wanda realized that she was going to have to pull herself up from her bootstraps and earn her way out of a lifestyle of poverty. She worked very hard and earned excellent grades in her high school class, 3rd in her class to be exact. She was offered a full academic scholarship to the University of Georgia where she graduated with high honors with a degree in Business Administration.

Soon after she was accepted to Emory University’s Law School. She would have to take out student loans to pay for tuition, books and a place to live.

The Dilemma (kind of)

Along with studying hard and making excellent grades as an undergraduate student at Georgia, Wanda also made some very good decisions with her credit. She was bombarded with credit card offers starting the first day she arrived on campus. Needing the use of credit cards for personal necessities and a little fun she gladly accepted numerous credit card offers.

Keep in mind that the household she grew up in never had credit cards because of frequent periods of unemployment, poor credit reports and poor credit scores. Wanda felt flattered that these huge credit card companies and banks were now offering her their credit cards.

Now that she was looking for a student loan it was time for her to apply for “non-credit card” credit for the first time ever. She filled out the application with a bank that offers student loans and was approved with no problem.

You see, Wanda had excellent credit scores, which made her student loan application very easy for the lender to approve. Her responsible use of the credit cards not only built up a solid credit report but also very strong credit scores.

Unfortunately this isn’t always the case with college students. In fact, Wanda’s story is more of the exception than it is the rule. There are tens of thousands of college students who mismanage their credit during their time in school and enter the post-scholastic world with poor credit and low credit scores – and frequently a lot of debt.

Arguably it’s not their fault. High school students are never taught to manage their credit and education on how to establish solid credit reports and credit scores simply doesn’t exist in any sort of comprehensive format. However, once these graduates turn 18 years old the credit card issuers, who want to be their first credit experience, will start targeting them. It’s proven that if a credit card issuer can be the first “in the wallet” then the consumer will remain loyal to that creditor for years to come.

So, any use of newly established credit could be referred to as “on the job training.” Some students use their credit responsibly and pay their bills on time and some view the new credit as a license to spend freely with optional payments due at the end of each month.

Many students graduate and enter the workforce with very bad credit and very low credit scores. This is a problem for several reasons:

• Poor credit will hamper their ability to find apartments and other rental units. They’ll likely have to pay higher deposits, higher monthly payments and might even be denied.
• Poor credit will make it difficult to find affordable auto insurance. That’s right, your credit information is used by insurance companies to determine whether or not they will give you auto insurance and at what rates.
• Poor credit will make it difficult to find affordable homeowner’s insurance. Credit information is also used by insurance companies to determine whether or not they will give you homeowner’s insurance and at what rates
• And maybe most important to a new graduate, potential employers have the right to review your credit reports while they are evaluating your application for employment. And some companies will use poor credit as a reason to deny employment.

This is perfectly legal. One of the 8 “Permissible Purposes” (the reasons defined by the Fair Credit Reporting Act which make it legal for someone to pull your credit reports) is to use credit for the purposes of pre-employment screening.

And, all of these difficulties could last for many years since negative information will stay on your credit reports for 7 to 10 years.

A College Experience And The “Time Series” Impact On A Credit Score

Wanda was kind enough to share with us her recollection of her credit usage over her 4 years of undergraduate school. We’ve simulated the impact her actions had on her score. You’ll be able to see how good and bad decisions can impact your scores over a shorter and longer period of time.

Freshman Year – Credit Scores Ranged From 625 to 675

Wanda establishes several new credit card accounts. Most of them have very low credit limits. In fact, her highest credit limit is $1000. She uses the cards for dorm room supplies and has a little fun with her friends - dinners, weekend getaways and, of course, Spring Break. She makes all of her payments on time but still has used a significant percentage of her credit limits, which keeps her scores below 700.

Sophomore Year – Credit Scores Ranged From 585 to 625

Wanda gets a little out of control with her credit and she maxes out most of her cards. And, she neglects to pay her bills for a couple of months while she is out on Holiday Break. Her credit scores drop from 675 to 585 in less than two months. She also has to pay late fees on her credit card bills. So, not only are her credit scores going down but she is also paying more interest and late fees. Having credit is getting more expensive and difficult to manage than she anticipated.

Junior Year – Credit Scores Ranged from 625 to 690

Wanda gets a reality check when she starts getting phone calls from the collection departments of some of her credit card issuers. She knows she’s headed in the wrong direction. She takes an inventory of all of her credit cards and catches up all of their payments. She also does her best to pay off the balances of some of cards.

Her scores increase to 690 by the end of her Junior year but that is still well below the national median score, which is roughly 725. The problem is that all of her late payments are still showing up on her credit reports as “historical delinquencies.” These late payments will be on her credit files for 7 years but over time they will lose their negative impact to her scores.

Senior Year – Credit Scores Ranged From 690 to 740

Wanda focuses hard on doing all of the right things. She works to pay off all of the remaining balances and then uses her cards very responsibly for the rest of the year. She is even able to convince some of the credit card companies to remove the late payments from her credit reports.

Her scores increase and at graduation she walks away with a diploma and credit scores that are all above 740. This will serve her well as she starts applying for student loans, an apartment and perhaps even a car loan.

Now we’ll simulate a more common scenario that doesn’t have quite a happy ending.

Freshman Year – Credit Scores Ranged From 625 to 650

A new college student, whom we’ll call Alex, establishes several new credit card accounts. As with Wanda, most of them have very low credit limits. Alex uses the new credit cards for dinners, parties, fancy new wheels for his car and, of course, Spring Break. When the bills start coming in he makes the minimum payments. Most of his cards are completely maxed out, which keeps his scores below 650 for his entire freshman year

Sophomore Year – Credit Scores Ranged From 518 to 545

Alex continues to make the minimum monthly payments but that doesn’t really allow him to continue to use his credit cards since he doesn’t have any available credit. So, he opens up more and more credit cards and continues his spending spree. And, he begins to miss monthly payments because he has so many. His credit scores begin to fall even more and he ends up the year with scores no higher than 545.

Junior Year – Credit Scores Ranged from 490 to 516

The trouble really begins when Alex stops making payments on most of his accounts. It’s been several months in some cases and the credit card companies have started sending the accounts to collections agencies. These collections are starting to appear on his credit reports and his scores are beginning to plummet.

His highest score is 516.

Senior Year – Credit Scores Ranged From 428 to 456

Alex graduates with a degree in Literature and three credit scores that are in the 400’s. His highest score is now 456. Scores like that place Alex in the lowest scoring 5% of all U.S consumers. He will have a difficult if not impossible time getting any credit, housing or any other benefit that depends on credit reports and credit scores as part of their evaluation. He will even have a hard time finding a job if the employer views credit histories as part of their background checks.

Alex files a Chapter 7 bankruptcy in order to get the creditors off his back. The bankruptcy will remain on his file for the next 10 years of his life. He is 21.

Summary

While Alex’s scenario is a simulation the story isn’t uncommon. People under the age of 25 file a significant percentage of all bankruptcies. They are simply not prepared to handle credit and understand the short and long term impacts of its mismanagement.

And, the fact that credit card companies and other creditors can so aggressively pursue young and inexperienced consumers certainly doesn’t help.

College students certainly learn that “every action has an equal and opposite reaction.” In the credit world this law of nature doesn’t apply. Good actions have equally good reactions and bad actions have equally bad and long lasting reactions.

Wanda overcame not only what some may have called a “dead end situation” at home growing up but it’s certainly not a surprise that she was also able to master credit management while mastering the law.

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