Credit is a touchy subject in the financial world. There are plenty of pundits who advocate for staying away from any and all credit, saying that you don’t need a credit score if you have cash. Unfortunately, that’s not reality. We will all need a healthy credit score at some stage in our lives in order to function in the world in which we live.
Why Is Your Credit Score So Important?
Your credit score gives potential lenders a picture of your financial habits so they can determine if they are willing to take a risk on you and give you money. Many people don’t strengthen their credit score until they reach the point where they need one, but the earlier you start, the better, since building credit takes time. While this is good advice for all of us, it’s especially important to teach your kids about credit scores, the purpose behind them, and how to develop a high score.
As parents, we want our children to enter adulthood with life skills that will help them make decisions and get ahead in life. A parent recently asked me if her son’s apartment lease or debit card would help him build his score, an example of a young adult who was being proactive and planning for his future. Unfortunately, neither the lease nor the debit card will do anything for him; he needs to have some sort of debt. It’s important to teach our kids the difference between good debt and bad debt and how each can affect their financial future. Here’s something to remember: debt requires discipline, as does success in life in general. If you or your child do not feel that you have the discipline to handle debt in order to build a good credit score, then having no score is better than having a low score. But if you are ready to set your child up for a bright financial future, take a look at these six ways to help your child build credit in the right way.
1. Get A Credit Card
The thought of giving your child a credit card may fill you with dread, but this is the ideal time to teach them how to properly manage this responsibility, when the stakes aren’t as high. Initially, they will probably only qualify for a low-limit card. Once your child establishes the habit of paying it off every month, even if the balance is only $50, they will slowly but surely build a decent credit score. If the credit card company offers to increase the card’s limit, your child should accept the offer but keep their spending at the same level it was with the low limit. The longer they do this and the higher the limit goes, the higher their score will climb. If you want to keep an eye on your credit score or let your child see the effects of their habits on their score, both Credit Karma and freecreditreport.com will allow you to run your scores regularly.
2. Research Secured Credit Cards
A secured credit card is a mix between a debit and credit card. The cardholder deposits some money, let’s say $250, into a savings account and then gets a credit card with a $250 limit secured against the savings. Your child could then use the card up to the limit and pay it off multiple times a month, or bill a small amount and then pay it off before the due date. If you go this route, make sure you look for a card that reports to all three credit reporting agencies.
As your child builds a record, they will then receive other card offers. At this point, they should keep the first secured card, but also open an account with a card that will give them points for the amount they spend. Those points could add up over time and give them perks like free travel.
3. Apply For A Credit-Builder Loan
The main purpose of these types of loans is to help people build credit. The money borrowed is not released by the lender but is held in an account until the loan is repaid. Think of it as a forced savings program that reports the payments to the credit bureaus. Many credit unions offer these types of loans.
4. Find A Co-Signer
This isn’t always an ideal option, as the co-signer is liable for any debt incurred, but if none of the other options pan out, this can help. If you don’t want to go this route, another option is to lend your child a small amount of money to obtain a secured credit card so that you know the extent of the risk you are taking.
5. Seek Credit For Rent
You pay rent every month, so why not try to get credit for it? Not every rental company will do this, but find out if your rent will be reported to the credit agencies, possibly through Rental Kharma and RentTrack.
6. Establish Good Habits
More than anything else, cultivating good financial habits will set your child on the path toward building credit. Here are some lessons to impart to your kids:
- Pay your bills on time every month.
- Pay 100% of your credit card bill each month.
- Keep your account open as long as possible.
- Use a low percentage of your limit.
- Check your credit score regularly to see if there are any discrepancies.
- Don’t open too many accounts at once.
These habits will not only result in a high credit score but will also provide a strong foundation for your child’s future. Take this as an opportunity to teach your kids the realities of debt and credit, because once they enter their college and career years, they will be bombarded with debt options and will need to know how to make informed decisions.
We Want To Help You
Managing finances does not come naturally to many young people, but it’s one of the most important life skills you will impart to your kids. We at College Planning America want to provide you with the tools to help you on this journey. For assistance in developing a college plan or a financial plan, email me at dcoen@sageviewadvisory.com or call 800-814-8742.
About Dave
Dave Coen is a Financial Advisor with SageView Advisory and the CEO of College Planning America. Along with his retirement financial industry experience, he is a College Planning Specialist. He works closely with individuals and families to provide them comprehensive financial planning that addresses all elements of their financial picture. Learn more by connecting with Dave on LinkedIn.
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