While many parents consider the financial implications of having children, they don’t always consider the importance of family discussions about finances. Having at least a basic understanding of personal finance is crucial for success in life. Eighty-seven percent of Americans agree that financial literacy should be taught in schools. Unfortunately, the reality is that few states produce financially literate high school graduates. A survey conducted by Chase showed that only one third of Americans were taught what a credit score is by their parents! So it’s up to parents to bridge the gap.
If you’re a parent, don’t worry — it’s easy to teach your kids simple money lessons. Even providing the most basic lessons like budgeting and building credit go a long way.
This guide covers the basics of how to teach your teen and young adult kids about credit to set them up for a healthy relationship with their finances, including:
- Setting them up for success
- Credit 101: basic concepts your child should know
- Conversations about credit
- Getting a first credit card
- Establishing good credit
- Preparing for college and beyond
There are things you can do even before your child reaches high school to ensure that they start off on the right foot with credit. There’s no hard and fast rule for if and when you need to do these things, so if you haven’t yet, use this as a first step in the right direction.
Check your child’s credit report when they turn 16
Unless a child is an authorized user or joint account holder on an adult’s account, he/she won’t have a credit score. Even so, the Federal Trade Commission recommends checking a child’s credit score around the child’s 16th birthday. This lets you correct any issues that may be caused by identity theft before your child turns 18 — the age when most of use first use and need a credit score.
To check your child’s credit report, send your written request to each of the major credit reporting agencies with:
- Your child’s name, address and date of birth
- Copies of your child’s birth certificate and Social Security card
- A copy of your driver’s license or other government-issued identification card
- A utility bill as proof of residence
Take precautions to protect your child from identity theft
Child identity theft has become increasingly common in recent years. Because kids’ data is a “clean state” and not being checked regularly if at all, thieves are more likely to prey on it. To reduce your child’s risk of identity theft, be aware of common warning signs and check your child’s credit score every six to 12 months.
A Javelin Strategy & Research report, the 2018 Child Identity Fraud Study, showed why identity theft among children is a concern:
- One million children (about 1.48% of minors) were victims of identity theft or fraud in 2017.
- Two-thirds of the victims of identity theft or fraud in 2017 were age seven or younger.
- Minors who are bullied online are nine times more likely to be victims of fraud than minors who aren’t bullied.
Watch for signs of fraud
If your child’s identity is stolen, the sooner you discover the problem the better. If you suspect a problem or notice any of the warning signs listed below, contact the major credit agencies for more information. Warning signs of fraud include:
- A credit card bill addressed to your child arrives in the mail.
- Debt collectors attempt to collect a debt in your child’s name.
- You’re unable to open a bank account for your child due to a negative history with credit bureaus.
- An unusual amount of pre-approved credit offers arrive in your child’s name.
- Your child is denied a driver’s license because one has already been issued in his/her name.
Consider freezing your child’s credit
Freezing a child’s credit is the best way to prevent identity theft. Parents, legal guardians or someone with power of attorney can place a security freeze on the credit reports of minors under the age of 16. And now, thanks to changes to the Dodd-Frank law, freezing and unfreezing you or your child’s credit at each of the three credit bureaus (Equifax, Experian, and TransUnion) is free.
If you want to request a freeze (or unfreeze), check out tips on how to talk to a credit bureau before contacting the bureaus.
Knowledge is the most basic element of good financial health. The most important thing to do is to educate your kids on how to use credit as a financial tool. Focus on the positive aspects of having a good credit score, while emphasizing that access to credit is a serious responsibility with the potential to cause lasting effects if used recklessly.
What is credit and why is it important?
Credit lets you and your kids “buy” goods or services before you actually pay for them, because you’ve proven that you can be trusted to pay in the future. Having good credit is important, because it’s used by lenders to decide to give you any type of loan, from big purchases like houses and cars to credit cards, cell phone contracts, renting an apartment and even getting a job.
Key terms to teach your children
- Interest rate: a percentage of the amount owed and that is charged to the borrower
- Credit limit: the total amount of money that can be borrowed
- Credit score: a three-digit number that indicates to lenders how likely a borrower is to repay debt, and that’s calculated based on credit history
- Credit report: detailed information on someone’s credit history
- Minimum monthly payment: the lowest amount someone can pay on a loan or credit card each month to maintain a good credit standing
Teaching your child what impacts their credit history is a good place to start teaching them about credit.
- Payment history: Payment history is one of the biggest influencers on your credit scores. Payment history accounts for approximately 35% of most scores. A history of on-time payments is good for your credit scores; while missing payments has negative consequences.
- Credit utilization: The second biggest influence on your credit scores is credit utilization. Your utilization rate is the ratio between the total balance you owe and your total credit limit on all your revolving accounts. It affects 30% of your scores’ totals. A lower utilization rate results in better scores. Maxing out your credit cards or leaving part of your balance unpaid can hurt your scores, because it increases your utilization rate.
- Length of credit history: The length of credit history is particularly important for young people. Unless you added your child as an authorized user on your credit card, he/she most likely won’t have a lengthy credit history to back up a credit application. Credit history accounts for 15% of most scores.
- Mix of accounts: A smaller percentage (10%) of your scores comes from your mix of credit accounts. Having a good history with different types of credit, like revolving and non-revolving credit, may help improve your credit scores.
- New credit inquiries: When you open a new line of credit, creditors will make an inquiry that stays on your report for two years. New credit inquiries account for the last 10% of your credit scores. While a few of these inquiries aren’t too impactful, it’s best to avoid continuously applying for new credit. It’s also important to note that soft inquiries are not counted towards this.
The different types of credit
- Secured lines of credit: Secured lines of credit are those backed by collateral. As a result, if the borrower doesn’t repay as agreed, the lender can repossess the collateral. Examples of this include car loans and home mortgages, where the collateral is the car or the home.
- Unsecured lines of credit: Unsecured lines of credit are those without a form of collateral. On an unsecured line of credit, the lender assumes a much larger risk and these types of loans usually carry higher interest rates. Most credit and charge cards are unsecured lines of credit.
- Revolving credit: Revolving credit is a type of credit that can be used repeatedly (with certain limitations), as long as the account is open and payments are made on time. Credit cards, lines of credit and home equity lines of credit are all examples of revolving credit.
- Non-revolving credit: Non-revolving credit is credit that can’t be used again once it’s paid off. Student loans are a type of non-revolving credit that you or your child may be familiar with.
When you talk to your child about money in everyday conversations, you can boost your child’s financial literacy without even sitting down to discuss big topics. A 2014 study by the Federal Reserve showed that people in states that mandated financial education have higher average credit scores as adults than people in states without this requirement. Odds are that there are some aspects of your monthly routine, like paying bills or checking your own credit score, that can become teachable moments for your kids. It can be helpful to have a real-world connection to draw from when you talk to your kids, so pull from your own experiences when offering offer one of these lessons.
When to introduce your child to the concept of credit
While there are money lessons your kids benefit from learning before high school, it’s never too early to teach the benefits of properly managing money. As your child approaches adulthood, it’s important to talk to them about credit and the many ways it affects their lives. Once they enter high school, you should to explain the basic concept of credit and start informing them of how actions, like paying the cell phone bill on time, impact credit scores and why that matters. Providing real-life examples is the best way to educate kids on a concept that is somewhat abstract.
Credit lessons to teach your kids
- There is such a thing as “good” and “bad” credit.
- Checking your credit reports and credit scores is an important habit to develop.
- Credit mistakes can be costly.
- Credit cards aren’t inherently bad, and when used correctly have financial benefits.
- Credit cards shouldn’t be used as a substitute for cash.
- It’s important to build an emergency savings fund even if you have credit cards.
- Creditors and lenders report your financial actions to credit bureaus.
- More credit cards aren’t always a good thing.
- It’s not a good idea to use all of your available credit.
- Closing a credit card can hurt your credit.
- The longer you take to pay the money back, the more it costs.
- There is a limit to how much you can purchase on a credit card.
In 2017, T. Rowe Price’s annual Parents, Kids and Money Survey found that the number of children ages 8 to 14 with access to credit cards had quadrupled in just five years. If you’re wondering whether you can get your teen a credit card, technically, children under age 18 can’t apply for a credit card as the primary account holder. However, you can add minors to your own account as authorized users if and when you feel they’re ready. When to give your child credit card access, is a personal decision for every family. When you’re ready, here are a few ways to go about it.
Credit card options for children under 18
- Have your kids practice managing credit with a prepaid card: A prepaid card doesn’t impact your credit score, but can be a good way for younger kids to get used to paying with a card.
- Designate your child as an authorized user on your card: Some card issuers require that an authorized cardholder be from 13 to 15 years old. Others have no age limitations. The primary account holder, and not authorized cardholders, is always responsible for repayment. So, any reckless spending will be up to you to pay and could hurt your credit score if you can’t repay on time.
Credit card options for children over 18
- Cosign for their first card: Even when your child turns 18, his/her credit history may not be robust enough to get a credit card of his/her own. If you feel that they’re responsible, consider cosigning for their first card. Like letting your child be an authorized user, any debts on a card you cosign on can impact your credit score as well.
- Apply for a secured credit card for your child: Another option for establishing a credit history from scratch is getting a secured credit card for your child. Secured credit cards require a security deposit that amounts to your line of credit. For example, a security deposit of $500 gives the card holder a $500 credit limit. It’s much easier to qualify for a secured credit card, and responsibly using one will help your child build credit. Here are a few secured cards to consider:
- Discover it® Secured
- Capital One Secured Mastercard
- OpenSky Secured Visa Credit Card
- Look for credit cards for students: Most major credit card issuers offer credit cards for students. These cards allow your student to use his/her time in college to build credit. Many offer rewards tied to textbook or entertainment purchases. Examples of student credit cards include:
- Discover it® Student chrome
- Discover it® Student Cash Back
- Journey® Student Rewards from Capital One®
Credit cards for families
There are several credit cards that are great for families. If you’re looking for a card that offers the best benefits for families, consider one of these:
- American Express Blue Cash Preferred
- Target Credit Card
- Chase Freedom®
- Wells Fargo Cash Wise Visa® Card
- Barclaycard Arrival Plus
It takes time to build credit, but once your child has access to a credit card, he/she can start. In addition to using a credit card responsibly, there are a few more ways your child can establish good credit. And, once your child has started establishing credit, encourage him/her to monitor one of his/her credit scores, which can be done for free.
Best ways for teens to build credit
- Add them as an authorized user to one of your cards
- Encourage your child to get a job as proof of income
- Consider a credit builder loan
- Use your home address as his/her permanent residence address during college
- Have your child pay for utilities if they live in an apartment during college
How long does it take to build credit?
Building credit takes time, but if your child starts early and practices good habits, he/she can establish a solid history with just 6 to 12 months of on-time payments.
Repairing credit mistakes
Building credit isn’t always smooth sailing. Watch for signs that your child might be struggling financially. Ruining his/her credit can cause him/her to struggle finding a place to live or even a job. It’s best to intervene early. There are a few ways you can help if things have already taken a turn for the worse, including:
- Give your child a security deposit for a secured credit card
- Co-sign for a loan
- Consider expenses that you could help eliminate
- Suggest credit counseling
For some teens, college is their first real experience with credit. Realistically, college students have more to worry about than their credit, so it may not be top of mind. Even so, college is a great time for kids to start building healthy financial habits independent of their parents. It can seem as though credit won’t affect students until later in life, but remind your child that credit can impact them sooner than they might think. Here are a few things you want your kids to be aware of at this stage of life.
Why college students should build credit
- Increases the length of their credit history
- Helps them get in to an apartment
- Plays a role in some job applications
- Helps them save on insurance
- Makes it easier to buy a car
- Helps them get student loans
Paying for college and student loans
Paying for college with a credit card is never a good idea. Using student loans, though, is a standard way to pay for college these days. Federal student loans don’t require a credit check or cosigner, which means borrowers can take on large amounts of debt with little or no indication that they can pay it back, unlike credit cards. However, if your child hasn’t considered the effects of credit before, a student loan can lead to major sticker shock at graduation. Some things your child should know before taking out a student loan include:
- There are two types of student loans — federal and private.
- Student loans have grace periods (a period of time after you graduate before you have to begin repaying the loan).
- The faster you pay off your loan, the less it will cost.
- Refinancing and consolidation are different things.
- Deferment and forbearance are available in times of need.
College graduates have their own set of things to watch out for with regards to credit. As long as you’ve followed these tips though, you can feel confident that your new graduate is responsible and can make his/her own decisions once graduated and is on the way to getting a job.
If you’re nervous about starting the credit conversation with your child, consider that 41% of all households carry some sort of credit card debt. You may feel uncertain about your own finances, unqualified to teach about a concept you’re struggling with, or like you’re protecting your children by not introducing them to credit. We all know the “do as I say, not as I do” method of teaching isn’t the most effective, but for as many reasons as there are for not teaching your kids about credit, there are always more in support of it.