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What Your College Student Should Know About Credit

04/25/2016 01:20 pm ET
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According to recent survey results, college students know almost nothing about consumer credit. Considering the lack of financial literacy provided in public schools, one could reasonably assume the blame should be placed on our educational system. However, I think parents need to step up and make sure the job gets done.

Why? Well, schools aren't required to teach your children how to tie their shoes, go to the restroom independently, or wash their laundry. So why should the responsibility of teaching children about credit lie solely on them? Lessons about finances and credit should be modeled and taught by parents and based on the results of this survey, there's a lot of work to do.

Does your college student understand what a credit score is? The numbers say 59 percent of them don't. Their lack of knowledge on what a credit score is has 19 percent of them believing a lower credit score is better than a higher credit score. Furthermore, 42 percent of them couldn't even tell you ways to improve a credit score. Should I go on?

If you have a child heading to college this fall, it's time to sit down with them and figure out if they know everything they should about credit before they are sent off and left alone to play with creditors. Today we're discussing what your college student needs to know about credit and why it's important.

Why is it important for students to know about credit?

All adults should know about credit, regardless of whether they choose to use it or not. Your eighteen-year-old may not be ready to purchase life insurance, make a will, or purchase a home, but they will have to manage their finances in some capacity during their college years.

If he or she decides to move off campus, they may be responsible for paying their rent. To keep food on the table and the lights on, they're going to need to know a little something about budgeting. With these adulthood responsibilities, they need to have a proper handling on their finances, because if they don't, they're going to run to someone and it's either going to be you or creditors.

Now don't get me wrong, some of them will get a card and swear they're only going to use it for emergencies. Perhaps a book that was left off the course syllabus which they'll need at the last minute, or maybe to cover a parking ticket or two. Regardless of their initial intent, it becomes easier to swipe that credit card than to plan responsibly. Before they know it, they've financed a bunch of little emergencies and lack full awareness of the consequences to follow.

If they find themselves in a situation where they can't pay their balance, do they understand how late payments affect their credit score? What about other areas of their lives like that future job they want to land after graduating? Or what about that fancy downtown condo they want to lease to go with that dream job? Oh and let's not forget about insurance rates or utilities. Do they know one wrong move with their credit will cost them financially in several ways? Unfortunately, this survey says they don't.

What do they need to know?

The definition of a credit score.

The first thing your college student should understand is the definition of a credit score. A credit score is a numerical summary of your credit risk, compiled by information reported by creditors to credit agencies. A credit score is used to determine the risk associated with lending credit to borrowers.

Credit scores vary according to the model being used by the reporting agency. The most common credit model is the FICO credit score. A FICO score ranges from anything below 600 (bad) to anything above 750 (good). Make sure your college student isn't among the 19.6 percent of students surveyed who believes a lower score is better than a higher one.

Credit isn't free.

The second important thing they should know is credit isn't free money. You pay interest on balances not paid in full by their due date. A $500 credit card limit does not mean you have $500 in free spending money. Credit is a loan and it will cost you if you don't pay it back in full and on time.

What is their credit score?

Last, all college students need to know their individual credit score. Out of the students surveyed, 72 percent didn't know their score. The impact of their credit score will outlive the impact of their SAT scores. A higher education is important, but make sure an equal emphasis is placed on financial literacy and smart money habits.

How can they responsibly build their credit?

To help your student responsibly build credit here are four things to consider:

1. Encourage them to build a small emergency fund of $500 to $1,000 dollars. If an emergency arises, they will have cash for those expenses versus incurring debt.

2. Help them obtain a credit card (or a secured credit card if they don't qualify for a traditional card).

3. Show them how credit cards can be used to pay for small expenses each month. This will them build credit.

4. Advise them to never charge more than what they can afford to pay in full each month. This will help them avoid paying interest.

Help your child learn about credit and give them the skills they need to develop wise spending habits. Don't send your kid to college to become book smart when they are incapable of answering simple questions about credit. Financial literacy needs to be a part of their education too and if the schools aren't going to provide them with sound principles and opportunities to put them into practice, make sure you do. I believe you already know what the consequences will be if you don't.

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