A good—or poor—credit history is something that will follow your teen throughout adulthood. Good credit may be the ticket they need to buy a home at an affordable price when they are older. Conversely, poor credit may prevent them from borrowing money, creating a financial hurdle for years to come.
The tricky part about building good credit is that it's a "chicken-and-egg" problem. It helps to have credit to build credit. And it’s difficult for your teen to convince a credit card company that they're responsible unless they've had a chance to prove it.
But you can help. It’s never too early to start talking to your teen about the importance of good credit, and to help them start building their own. Guiding them through this time can be invaluable on their path to becoming a money-savvy adult. Here are 5 tips to share with them to build healthy credit.
1. Talk about getting a job
Income is a key factor in qualifying for credit. Explain to your teen that their income impacts their ability to be approved for a credit card, because that is how credit card companies know they could be capable of paying the bill. Credit card companies will know that a teen won't have a full-time job—but even part-time work can establish a pattern of responsibility.
2. Give them hands-on banking experiences
Whether you open a savings or checking account at a traditional bank or a cash management account at a brokerage firm, your teen should learn how to bank and how to handle an account like an adult. You have to walk before you can run, and in the credit space, knowing how to bank and budget well will help your teen use a credit card effectively.
Make sure they know the differences between a debit card and credit card. A debit card lets them use their own money to pay for their purchases, while a credit card is essentially a loan where they borrow money from a credit card issuer and then must pay interest on that loan if it is not paid by the statement’s due date.
Budgeting and spending responsibly can be essential for long-term financial health and habits. This could be a great time to teach your teen how to create a budget so they keep their spending in line.
3. Consider adding your teen as an authorized user on your card
If it makes sense for your family, you could consider adding your teen as an authorized user to your credit card account. As an authorized user they would have permission to use a credit card but are not legally required to pay the bill. As the primary cardholder, the account—and the bill—still belong to you.
As an authorized user on a credit card that's managed responsibly, your teen can benefit from your positive financial habits while starting to build their own credit history. The authorized signer’s credit card account will be added to your teen's credit report. The rating agencies don’t give a lot of weight to this, but it starts to build a positive pattern, and can help them when they apply for their first credit card on their own.
4. Teach them good habits from the start
When your teen has a card, or is successfully using yours, it's important to make sure they know how to handle a credit card responsibly. If it’s their own card, your teen should make sure to pay their bills on time every single month. Payment history is the one of the main factors in determining a credit score. More importantly, teach your teen to never charge more than what they can pay, and to treat their credit card just like it's a debit card. It's wise to not just pay the minimum on a bill but pay off the entire balance each month.
They should also make sure to use cards safely. Credit card fraud and identify theft are major risks. Most cardholders aren't liable for fraudulent charges on their cards, but you still have a responsibility to keep your information safe.
Be proactive to reduce the risk of fraud by reviewing your own and your teen's monthly credit card statements and checking your accounts online frequently. Keep your receipts so you can compare them with your monthly statement and charges. Then, notify your card issuer if you spot any transactions that you don't recognize. And, of course, report a lost or stolen card immediately.
5. Help them understand credit scores and reports
All debt is generally reported to credit rating bureaus, which track your credit history. For your teen, this may be new news, so be sure to walk them through how it works. Once credit has been established, they should check their credit reports annually through AnnualCreditReport.com to make sure the information is accurate. The 3 main credit reporting companies are required to provide a free credit report every 12 months.
These credit bureaus use credit scoring models to produce a credit score. The most common credit score is called a FICO score, which ranges from very poor at 300 to exceptional at 850. The higher the score, the more confidence your teen’s creditors will have in their ability to pay their debts. The score can be determined considering factors including credit usage, payment history, length of credit accounts, and credit inquiries. It's important to note that while the credit report is free once a year, the credit score often is not. Bureaus may charge a fee to see your credit score. However, there are third-party sites where you can check your credit score daily for free.
When your teen is just starting out, their credit is brand new, the slate clean. So now's the time to provide the tools they'll need to succeed. When you give your teen the gift of financial knowledge and teach them responsibility, the benefits can be lifelong. If they take care of it, their good credit will take good care of them.