Starve A Banker

Where is my son’s free pizza? Or tee-shirt?

See, during the first weeks of college, banks with folding tables and chairs scattered around campuses used to feed (or dress) my kids for free. All the students had to do was apply for a credit card.

Alright, so the practice of merchandise giveaways to entice college kids to apply for credit cards at public universities in California was banned two years ago by Gov. Arnold Schwarzenegger.

This ban is now being extended nationwide by the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009: no freebies in exchange for credit card sign ups on or near campuses anymore. While the term “near” remains undefined, the new law goes well beyond the college campus: it forbids the marketing and issuance of credit cards to people under the age of 21 unless they have adult co-signers or show proof that they have the means to pay off the debt.

The good news is: with far less credit cards around college campuses, the debt burden on Generation Y is going to lighten up significantly over the next few years.

Is there a flip side to this coin? Will the macro-economic benefits of a less indebted youth be obtained at the detriment of the students’ financial freedom? What are college students and their parents supposed to do?

Here are some options:

• Deposit, say $1,000, as the security for a secure credit card. This would give the young cardholder a line of credit somewhere between $500 and $1,000. Regular payments are expected to be made, like with a regular credit card, but should the student default on a payment, the card issuer has the option of recovering the cost of the purchases paid to the merchants out of the deposit. The deposit would act as the “means to pay off the debt”, as stipulated by the law, although it is not yet proven that security deposits would be considered as such.The advantage of the secured card for a student with no credit history is that most issuers report regularly to the major credit bureaus. This allows for starting to build of positive credit history.The major drawback is that fees and service charges for secured credit cards exceed the already skyrocketing fees charged for ordinary non-secured credit cards.  If you think that banks will happily open new lines of credits to young users, think again: in the past 12 months, banks have reduced credit lines by $1 Trillion.

  Also, it is customary that the deposit is not used by the issuer when one or two payments are missed, but is used at the time of closure of a delinquent card, when the balance exceeds the credit limit, leaving the student cardholder with a debt AND losing the deposit.

• Get a credit card with the parent as a co-signer. Although this sounds quite straightforward, this is also quite dangerous: any mis-handling by the student can severely damage the parent’s hard-earned and long-standing credit record.It also is a double-edge sword with respect to transferring financial responsibility to the young user: while a longer parent-child interaction is probably good for building up financial savvy, it can have the opposite effect of reducing the young users’ motivation to become accountable and autonomous.
• Stay away from credit cards altogether and stick to a checking account with a debit card. Here, there is no risk to the parent, but the dreaded overdraft fees and other minimal balance and account maintenance fees are lurking.
• Get a prepaid card account, which is similar to a checking account coupled to a debit card, but without the overdraft fees. Of course, some prepaid cards are loaded with other fees, as discussed in an earlier post, but you can shop around easily for the lowest cost choices.  Some prepaid card accounts like iBankUP.com include the ability to create on-demand paper checks from an online interface, this offering the equivalent of a checking account.Some prepaid cards are specifically intended for students that receive financial support from their parents. They feature a dual online access, one for the student and one for the parent, including the ability for the parent to program an automatic allowance.Yet other prepaid cards offer a bill pay service with the option of reporting payments to second-tier credit bureaus; this allows the cardholder to start building a positive credit history.

Here is a summary of the pros and cons of each option: