Considering helping your teenager, college student, or young graduate establish a credit rating?
Maybe they’re fresh out of school and don’t have any real job history yet. As a parent, what can you do to help your teenager or young adult build their credit? And should you? Is it even a good idea? If so, what are some better strategies?
Oh, to be Young!
People in our Western society are doing things younger and younger, much to the chagrin of many. Credit cards—often a hotly debated subject, regarded as both important and dangerous by some, and just plain dangerous by others—are one of those aspects of life our kids are exposed to at younger ages.
Twenty-five years ago, it was already common for college students to be approached by the credit industry. Many students back then would get started by being added to a new card opened by a parent, and the fact that the account was shared with a parent helped the youth stay careful and conscientious about its use. Additionally, credit card companies realized what a good risk pre-professionals in college were and made obtaining credit relatively easy.
Today, it is still easy to find a variety of college-age offers, often featuring university mascots or other young-adult-appealing imagery, offering incentives and perks that attract the younger demographic—such as credits on Zappos.com or certain restaurant discounts.
These cards are now more tech-enabled for the “electrate” (literate with electronic media) public they serve, offering interactive online management tools and text and email alerts. These features promote card use while also raising the probability of proper use by students.
Prepaid & Secured Credit
Prepaid money cards from VISA, MasterCard, and American Express—intended for individuals between the ages of thirteen and twenty-five—are now widely available. Since these are prepaid cards, the child may not actually be introduced to credit per se. The real benefit lies in a parent’s ability to transfer money to their child almost instantly, from anywhere.
Parents often have nearly total control over prepaid teen cards and how they’re used. They can not only monitor usage online, via email, or text, but they can also lock and unlock the cards by sending a text message with a code. Spending limits can be set, and purchase alerts can be received.
But how young is too young?
The young teen’s use of electronic payment methods—while an unavoidable part of the new age—could be either a positive or negative experience, depending on several factors. Will they become responsible early on, learning to keep their card secure, track purchases, and understand the value of money? Or will they become accustomed to logo-card spending, detached from the consequences of parting with cash?
Rewards
What are the advantages of early use of credit cards? Credit card companies claim that early use helps establish a positive credit profile, allowing them to make major purchases—such as a car or a house—on good terms. They also promote cash-back and other rewards. However, these rewards may primarily serve the companies’ vested interests in encouraging increased spending, with the child focused on perks rather than making smart purchase decisions or practicing restraint. So, setting up a teen with incentives to spend—other than teaching them responsible money management—sounds like a mistake.
The evidence of reckless spending—on unnecessary and unaffordable things—is literally everywhere. Getting them started young might be the mistake. After all, we have juvenile courts for a reason: A person’s prefrontal lobes don’t fully develop until around the age of twenty-five.
Brains
“The prefrontal cortex, the part of the frontal lobes lying just behind the forehead, is often referred to as the ‘CEO of the brain.’ This brain region is responsible for cognitive analysis, abstract thought, and moderating ‘correct’ behavior in social situations. The prefrontal cortex takes in information from all of the senses and orchestrates thoughts and actions to achieve specific goals.” (1)
This doesn’t necessarily mean we shouldn’t start teaching children how to use money—and even how to use credit—but it most likely means we shouldn’t let them handle it without oversight until they’ve demonstrated competence, much like we would with a car.
The consequences of an early credit mistake could have long-lasting effects. They might damage their ability to buy a car or house for years—and who do you think they’ll come to for assistance when that happens?
Just as we teach teens to drive, we should educate them about credit. Of course, the best way to teach is by example. Otherwise, consider this approach:
- Provide oversight until they prove competence (for both of your sakes!)
- Make them aware of—and perhaps even let them experience—usurious late fees and annual fees
- Explain interest rates with examples of how they can affect payments (and quality of life!)
- Combine the experience with lessons on checking and savings if they haven’t already explored these
- Balance responsible spending education with habits of saving, perhaps by encouraging them to save 10% of all income
- Consider their sources of income: Do they work, or is the money just given to them?
Like any skill that requires some smarts to handle safely, credit education can be successful at an early age if approached as described above. Don’t just train them to spend a certain way—incorporate income and savings as equally important lessons.
- If you decide to help them start with credit as a teen, as we discussed, it’s recommended that you open a joint account that you have access to. Your involvement and ability to make a quick payment could save them from negative marks if they neglect their payments for a month (or longer!). It’s better to take the card away than to let them start off with bad credit—or risk your own.
- Secondly, the factors to consider when choosing a card, such as interest rates and fees, should be discussed with your teen. They should be aware of these factors and make the decisions themselves—rather than you choosing for them and just presenting the card.
- The incentives offered—while we criticized them earlier—could actually play a role in your card selection, as they are generally paid for by merchants and thus serve as indirect freebies (although they can lead to higher prices—be sure to explain this too!).
- Help them understand that credit is a sensitive area of life: It has benefits, but can also be dangerous, and is ultimately a privilege—not a right or necessity. In fact, financial advisor Dave Ramsey recommends that people coming out of bankruptcy avoid re-establishing credit, as that’s what got them into trouble in the first place!
- You might consider graduating them from a co-owned card to a secured card for the psychology of it—knowing they have something at stake.
- Encourage them to not only pay their balance every month, but also to enter each purchase as a debit in their checking account ledger. By doing so, they will spend more wisely and ensure they have enough money to pay off the card each month—at least that’s the hope.
- Ensure they understand that using a true credit card means borrowing money, and it must be paid back under the agreed-upon terms, usually with interest—meaning purchases actually cost more in the long run.
- Adding a teen to your own card(s) no longer helps them establish credit as it once did due to recent changes in Fair Isaac’s rules. Be sure to explain what Fair Isaac is and how credit scores work!
- The internet makes searching for prepaid, secured, and student cards overwhelming. It’s a great place to scour various offers with your teen for the educational experience. This is also an opportunity to teach them about online scams, credit card fraud, and identity theft. You may find an offering you and your teen both like. Consider walking into your local bank with them for a card. It’s a valuable experience, especially after seeing what’s available online. They may end up knowing more about credit than many adults!
Summary
Overall, if your teen has expressed an interest in using plastic, this is an opportunity to introduce them to a host of basic financial management skills. It’s recommended to align your teaching with their interest in credit.
Give them too little, and—well, they’re teens!—they may resent you for it. Give them too much information, and they might not want the cards at all! In fact, that might not be such a bad thing.
In all seriousness, this is another exciting opportunity to prepare your teen for the world they’ll soon have to navigate independently. Given the financial crises all around us, paying special attention to basic financial skills—including credit—at an early age isn’t just a good idea; it’s a great idea.
