Should you co-sign for your kid's credit card?
What constitutes an emergency in college has never been well defined. For freshman Hannah Li, for instance, this month it has already meant a manicure, a J. Crew sweater and a plane ticket to Paris for spring break. "Now you see why we put her on a $1,000 limit," Hannah's mother, Alice Park, said of her 18-year-old's "emergencies-only" prepaid credit card. "We want to teach her independence — just not with free access to our money."
Sending your child off into the world with sound financial sense has long been a challenge for parents. This fall, however, many face an added burden: whether or not to co-sign for their child's first credit card. New federal regulations aimed at keeping young Americans out of debt now ban banks from issuing cards to anyone under 21 unless the person has a co-signer or demonstrates independent means to pay bills. "Every parent has to do that gut check on whether their kid is responsible enough," said Bruce McClary of the nonprofit ClearPoint Credit Counseling Solutions in Seattle. "Or is he going to go crazy? Throw a keg party, hire a band and buy pizza for the whole dorm?"
Indeed, introducing young people to plastic has long yielded precarious results. College students especially in the past proved to be suckers for free stuff, such as t-shirts and Frisbees, and the fallout was extra credit cards and heavier debts and late fees along with them. In 2008, the average undergraduate carried $3,173 in credit card debt, according to surveys done by student lender Sallie Mae. A new study released October 25 by the Federal Reserve found 53,164 credit card accounts were opened last year, thanks to agreements with universities and other higher-ed institutions.
Horror stories of ruined credit scores and crippling debt loads prompted Congress last February to pass the CARD Act. While widely applauded, the added restrictions now pass on responsibility to parents to decide whether their youngster is ready for credit. And, so far, most parents report the answer is no. In an online poll commissioned last July by the National Endowment for Financial Education (NEFE), 61 percent of parents surveyed said they would not co-sign for their child to have a credit card. Another 16 percent said they weren't sure whether they would co-sign.
Instead, many families are opting for alternatives. One popular option, for example, is linking a child to a parents' own credit line. "This helps students start to establish their own credit history, and that's a good thing," said Ken Lin, CEO of the website CreditKarma.com. "It also lets parents monitor spending activity and teach lessons along the way."
This is the route James Gallo chose when he sent his daughter off to college this fall. Explaining his decision, the New Jersey father of two likes to use the analogy of learning to swim. "First, they go in with a life jacket — a card linked to my account. Then, maybe some ‘floaties'— a co-signed card. Then, they go in the water by themselves, knowing that I am by the pool ready to throw in a line when they screw up," Gallo said. "Finally, after they swallow a little water, they come out with respect for the water but knowing they can swim alone."
Debit or credit?
Still, as with co-signing for a card, linking accounts also means putting a parent's own credit at risk if a student falls behind in payments or maxes out limits. Or vice versa. "Is your own credit fragile?" Ted Beck, NEFE's CEO, suggested parents must ask themselves. "Because, if so, you're transferring bad credit on to your child. It may be better to look into a debit or prepaid card."
A debit card allows young people to draw solely from available funds in a checking account. Prepaid accounts work similarly, only letting transactions go through if users have sufficient monies in a previously set-up account. Neither affects credit scores for good or bad, making some parents hesitate if they want to assist students to start establishing a credit history. "If a child hasn't shown themselves responsible enough to have their own credit, it's not worth pushing," said Craig Evans Carnick, a certified financial planner in Colorado. "Co-signing a car loan or a mortgage after graduation is an equally good option."
If parents do decided to co-sign for a credit card, experts universally agree it is important to keep limits low, usually to no more than $500 to $1,000. The new federal rules also prohibit such limits to be raised without a co-signer's approval. Additionally, credit card companies are banned from offering freebies while soliciting credit card applications while on or near college campuses and from receiving details about borrower under 21 from credit reporting agencies.
Beware of loopholes
Not surprisingly, some younger college students have already found loopholes to evade the new regulations and secure credit cards on their own. Tricks include signing up for business accounts, which don't fall under the CARD Act, or asking friends over 21 to co-sign rather than parents. "Here, parents should also check in with your kids and ensure children over 21 aren't co-signing for younger students," Beck said. "We all have friends we like to help out, but you're putting your credit at significant risk."
In another common practice, college students all over the country are automatically receiving plastic cards emblazoned with the logos of both MasterCard and the college they're attending, which are often linked to accounts created for student loans. "This is very scary to me," said Sharon Burns, a professor in Purdue University's Department of Consumer Sciences and Retailing. "It's like using a credit card against a home-equity line, which no responsible consumer would ever do."
Of course, responsible budgeting and spending starts at home. Parents should start talking to children early about money and not be afraid to rely on their own mistakes in the past to teach good habits. And if kids, like Hannah Li, aren't using their credit cards smartly, "that's when you cut them off," Burns said. "It will teach the importance of staying on budget — it never hurts to let a young person to go hungry for a day."
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