Despite new credit laws, young adults can still fall into traps: Don’t let them–know your options for them and for you

August 30th, 2010 by Mike Hinshaw

In our most recent post, we surveyed news of the economy and discussed the machinations of at least one company that already is egregiously flouting the new credit-card reform law.

One article we cited was from the St. Louis Post-Dispatch, which describes how  First Premier has concocted “pre-account fees” that somehow obligate consumer before opening an account.

Avoiding credit traps

Another aspect of that piece is worth mentioning, too: Whether you are considering bankruptcy protection or about to your bankruptcy finalized through discharge, you may feel you need at least some kind of credit card. Of course you don’t want to fall in the same trap described in the Post-Dispatch piece. But, as the article points out, diligent shopping may turn up a decent secured card.

“Consumer advocates say people with bad credit would be better off with ‘secured’ credit cards,” says the article, “which are common among major banks.

Secured credit cards

“Consumers place money, often $300 to $500, on deposit with the bank. The bank then gives them a credit card with a limit of the deposit amount, or somewhat more. Many such cards carry annual or monthly fees, although some don’t, and some carry application fees. There are bad deals among secured cards, but there’s enough competition that consumers can find a reasonable offer, advocates say.”

If you’re intent on rebuilding your credit score, using a decent secured card is a reasonable way to start. Through time, you may build up to having real credit extended–or qualify for a better card. Obviously, if misusing consumer credit was a problem in the past, you’ll need to be vigilant about not repeating past mistakes: a secured card can help make baby steps to staying in bounds.

Considerations for college kids

Some consumer advocates even recommend a secured card for college-age children–especially now, in light of the portion of new regs aimed at the under-21 crowd. With the fall semester kicking off, these are timely questions. Furthermore, weighing the risks and benefits of credit for young adults can also be a worthwhile exercise for recession-pressed households because some of the same questions apply to budgets and rebuilding credit.

As noted last February in the University of Iowa’s Daily Iowan, “Starting Feb. 22, students under 21 will be required to have a cosigner or show proof that they can independently take responsibility for any debt when applying for a credit card.” In other words, to get around having a co-signer, they’ll have to prove regular income or demonstrate a solid savings account.

Credit reform watered down

Well, that’s the idea behind the new regs. However, it may come as no surprise that despite the tougher-sounding regs of the new law, the intent is already getting creamed. In other words, the combination of determined youngsters and willing lenders can result in not much having changed. From a May 20 piece at CreditCardGuide.com:

“The student card segment of the new Credit CARD Act was designed specifically to protect young adults under age 21 from falling into the debt trap early on. With this in mind, Congress drafted provisions specifying that those under 21 can only receive credit cards if they can demonstrate sufficient income, or get a cosigner for the card. It was left to the Federal Reserve to specify what constituted ‘sufficient income,’ and how exactly it must be demonstrated.”

In other words, Congress punted. Oh, and guess what? The Fed punted, too. So the whole thing gets stair-stepped down to the credit-card companies setting policy.

“The Fed chose to apply vague standards for evaluating income, simply requiring card issuers to have ‘financial information indicating the consumer has an independent ability to make the required minimum periodic payments on the proposed extension of credit.’ The Fed explicitly declined to follow suggestions from consumer advocates that card issuers be obliged to only consider income earned from wages, as well as requiring a higher residual income or lower debt-to-income ratio for consumers less than 21 years old. The Fed also declined requests that card issuers be compelled to verify income or asset information stated on applications submitted by consumers under the age of 21.”

So what’s new?

Doesn’t off much hope for the new financial reform act, does it? We see the same stair-stepping in the regs, with the agencies left to promulgate the actual rules. Can we expect the regulated industries to wind up setting policy, there, too?

For young-adult credit cards, says CreditCardGuide.com, “The upshot is that getting a student credit card in the post-credit card reform era appears to remain as easy as ever—with little else required than going online to fill out a credit card application, no co-signer required. Credit limits on new student credit cards range anywhere from $300 to $2000 or higher, and credit limits increase over time for anyone paying their credit card bills on time.

“One major credit card issuer has set the ‘sufficient income’ level for those under age 21 at a mere $2,000 per year. Applicants are allowed to include scholarships, grants, and parental contributions in that total. Since these sources of income for most full-time students would exceed more than $2,000; effectively any student under the age of 21 could be approved under that guideline.”

Wise use of credit starts at home

Bottom line? Make sure your college-age kids understand that they have your support as long as they don’t skirt the intent of the law by signing up on their own with one of the rogue lenders.

Accordingly, you will need to consider: is it wise to co-sign on a card for a college student–especially one who is leaving home for the first time? Perhaps the child would be better off with a debit card–one that  is NOT tied to so-called “overdraft protection,” a misleading term for “more ways for the bank to charge fees.” (One suggestion: sit down with the child and read this Consumer Affairs discussion of debit cards vs credit cards.)

On the other hand, many parents also would like to be help their kids get their own credit ratings established. With that in mind, here’s some options from “Should you co-sign for your college-bound kid?”:

  • A low-limit, student card they can use as a starter card: “These cards typically have a credit limit of $1,000 or less and no annual fee. Some offer no interest on balances for the first 6 or 7 months.”
  • The aforementioned secured card, which also beings establishing credit history: You may have to shop around to avoid exorbitant fees, but the “spending limit is based on a deposit with the bank. Usually, there’s a minimum deposit of $300 to $500 required. If they can’t pay the bill, the bank uses that collateral.”
  • Let them piggyback on your card: Despite the changes in the law, you can still let children become “an authorized user on your credit card account. Since you get the bills, you can see how much they’re spending and what they’re buying. Because they have a real credit card, they are creating a credit history.”

Breaking the cycle

The article says one Virginia couple, Stephen and Cheryl Wiley of Glen Allen, Va., chose to piggyback for their two daughters. “The Wileys did not want the girls to have their own credit cards. But they wanted Kelly and Katherine to have a way to pay in an emergency and start establishing credit. The authorized user cards do both of those things.

“The girls know the rules. The cards are for emergency purchases only.  Any charges must be paid off by the due date. If not, their name will be taken off the account.

“The Wileys say there’s a reason they’re so strict. Back in 1990, they had to file for bankruptcy protection because of medical bills. They know how a bad credit report can hurt you and they don’t want that to happen to their daughters.”

[Next time: Perhaps an unfamiliar term, plutonomy has entered the lexicon to describe our wealth-gap economy.]

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The bankruptcy reform act of 2005 increased the complexity of the law, but if you are overwhelmed by debt, filing for bankruptcy protection may be your most pragmatic alternative. If you are facing foreclosure of your home (sometimes referred to as your “primary residence,” as opposed to a second home, or “vacation home”), bankruptcy protection may be your best route to saving the home. If you are struggling with medical bills, you may be in a special category for setting debt aside, and if you have problems with credit-card debt, you should be aware that some of those laws have changed recently, too. Whatever you do, before making major, life-changing financial decisions, consider consulting a trained, experience attorney. For bankruptcy basics, please see:

Principles of bankruptcy

Basics of bankruptcy

Introduction to Chapter 7

Introduction to Chapter 13