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Credit cards and college students

The Level 1 article in our latest Sound Mind Investing newsletter — Big News on Campus: New Law Limits Credit Card Pitches to Students (subscribers' link) — focuses on changes in credit card rules that will directly affect teenagers and young adults.

Among them: Under the Credit CARD Act of 2009, card issuers are not supposed to open accounts for anyone under age 21 unless the young person has "sufficient income" and an "independent ability" to repay. (Alternately, an underage applicant can have a financially responsible adult co-sign on the account.)

But neither the CARD Act nor the regulations issued under the Act by the Federal Reserve clearly define "sufficient income" and "independent ability." The result: confusion.

CreditCardGuide.com (a site affiliated with well-known Bankrate.com) has been checking around to find out how various credit card companies are responding to the unclear rules.

Without specific standards for what it means to have an "independent ability to make required minimum payments" nor for proving such "ability," it has been up to card issuers to lay down the policies. The outcome, not surprisingly, is a mixed bag of vague and lenient policies....

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.

Other card issuers don't give specific income information in the online application material, nor guidelines for which sources of income are acceptable. In online chats, however, customer service reps from several card issuers specifically stated that personal income may include other income than employment income, including financial aid such as grants — and even loans.

As for verifying any stated sources of income, the verification process for that income appears to be as loose as the income requirements themselves. For example, when asked how proof of income should be provided, the customer service rep for one card issuer in an online chat replied, "On the application, put how much income you have in one year." When asked if the card issuer would call for verification, the rep indicated that there would be no following up.

The potential problems are apparent: some young people will no doubt stretch the truth on card applications, claiming income that doesn't exist; others will simply claim students loans or grants as income, making the new rules largely ineffective.

Asked how card issuers will gauge "sufficient income," Gerri Detweiler, a personal finance expert for Credit.com, told SMI that credit reporting agencies will use "capacity scores" for young credit card applicants. They're "similar to credit scores in that they gather information from various sources and predict an applicant's ability to pay," she said.

Of course, credit agencies will have a limited amount of data on which to draw because most young people lack a financial history, so it is unclear just how helpful a "capacity score" will be.

Whatever the challenges of implementation, these new rules are now the law of the land. We'll simply have to "wait and see" to judge their effectiveness.

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