Credit Card Usage in College - How Does it Affect Me Later?

Reader Question: "Like most college students, I rely heavily on a credit card for daily living (no income at the moment). How will my credit usage affect me later on, like when I want to buy a home someday?"

I'm glad to see you are thinking about these things now, when you're in a position to manage them. There is a strong connection between your current credit card usage, while you are in college, and your financial picture later on down the road. It all comes down to how well you manage your credit and your debt.

The best way I can explain this connection is through a hypothetical scenario. So let's look at the story of John and Jane, two college students who use credit cards to cover certain living expenses.

John - A Credit Nightmare in the Making

John uses his credit card a lot. Hey, he's a college student after all. And like most students, he doesn't have any significant income at the moment. But he does have living expenses that need to be paid for in some way. So he relies heavily on credit.

Unfortunately, he also has a habit of missing his payments, and he has compiled quite a lot of debt as a result.

When John graduates from college and moves into the "real world," he will have two things going against him (financially speaking). He will have a lot of debt and a bad credit score. Your history of making bill payments is a huge part of your credit score, so all of those missed payments will have taken a serious toll on John's score. And since John has nearly maxed out his credit cards, his utilization ratio will be very high. This will also lower his score.

In fact, when you look at this FICO scoring chart, you'll see that payment history and utilization ratio account for the majority of your credit score. So these things will haunt John for quite some time. The late payments will follow him for up to seven years, and the high balances will linger until he makes a conscious effort to pay them down.

So how does this irresponsible usage affect him later on, when he tries to buy his first home? For one thing, he will have a lot of debt to contend with. This will affect his debt-to-income ratio, or DTI, which is one of the key factors a mortgage lender will look at when reviewing his application. The lender will also look at John's credit score, and we have already talked about the damage he has done there.

Sure, you can improve a score, but it can take months or years of "good behavior" to do this. So John has a lot of work to do before he can get approved for a home loan -- or any other major financing, for that matter.

Jane - A Model of Responsible Credit Use

Jane, on the other hand, manages her credit and debt very well while in college. Like John, she also has a credit card, but she only uses it for small purchases. More importantly, she always pays her balance down to avoid accumulating too much debt.

If you're going to use a credit card during your college years, this is the ideal way to use it -- make small purchases as needed, and make regular payments to keep the balance low.

A few years later, when Jane is ready to apply for a mortgage loan and buy a house, she will have an excellent credit score. By making all of her payments on time, and by keeping her balances low, she has been a model responsible credit usage. Her debt-to-income ratio will also be in good shape, because she'll have very little debt to wipe out her income each month. In short, Jane is a good position to purchase a home, as long as she buys within her means.

Use Your Credit Cards Wisely

I am not telling you that you need a credit card to survive your college years. If you can get by without one, that's fantastic. But the fact of the matter is that most college students need credit to cover certain living expenses. If you fall into this category, you need to be responsible with your card usage, because it will follow you for years. Your credit report tracks financial activity as far back as ten years, so your actions in the present can haunt you in the future.

Here are the key points you should take away from this lesson:

• How you manage (or mismanage) your credit now will affect you for a long time.
• If you have to use a credit card while in college, use it for small purchases only, and make regular payments to keep the balance low.
• Pay careful attention to your card balances. Many people rack up a lot of debt simply because they ignore their balances.
• Making all of your payments on time and keeping a low balance are two of the best things you can do to raise your credit score.
• Your card usage in college can affect your chances of getting a mortgage loan later on, so you need to take it seriously.

I hope this answers your question, and I wish you all the best with your financial future.

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