As a financially responsible adult, you likely understand how important good credit is to a successful financial future.
Learning sound credit card habits is an excellent way for your child to learn about financial responsibility, independence, and growth. So when should your children start building their credit?
Early on, kids must learn that these plastic cards aren’t synonyms with an endless supply of money.
Let’s explore some ideas on how to teach your children about building credit and making smart purchases.
Teach The Difference Between Debit and Credit
While debit and credit may have the same suffix, they have opposite meanings.
- Debit Card: A card that allows you to pull money directly from your bank account.
- Credit Card: A card that allows you to borrow money from a third-party lender that you must pay back in the future.
The difference between debit and credit is a fantastic teaching moment for children. Here’s an idea.
Next time you’re in the grocery store checkout line, show your child the two cards in your wallet (debit and credit). Explain to them what the difference is.
If you have $1,000 in your bank account and use your debit card to purchase $100 worth of groceries, you now have $900 in your bank account.
If you use the credit card instead, you will have to pay back the $100 a month later to the credit card company (with the funds in your bank account).
The Value of Excellent Credit
If you can prove to third-party lenders that you are responsible and pay off your credit card every month, you will be rewarded with a great credit score. This score (a number between 300 and 850) will impact your ability to take out loans in the future. The scoring system typically looks like this.
- Excellent: 800 to 850
- Very Good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Poor: 300 to 579
Your child may be wondering why they need to take out loans or have a high credit score. So what should you tell them?
4 Benefits Of An Excellent Credit Score Your Kids Should Know About
Credit impacts a myriad of day-to-day elements. Here are a few your kids will experience one day.
To rent an apartment, you will need to prove to the owner that you are likely to pay the rent every month. One indicator landlords use to decide is your credit score. If you have a poor credit score, you may not be approved for the apartment you want.
When your child wants to put down roots and purchase a place of their own, they’ll be looking to secure a mortgage to afford the purchase. The lender will also assign an interest rate along with the principal payments.
An excellent credit score will reduce the interest rate and ultimately save your child money over the life of the loan. Let’s look at an example.
Say you take out a 30-year mortgage loan for $300,000 with an interest rate of 4%. In that case, your monthly payment will be about $1,432. But if the interest rate were 5%, the monthly payment would jump to $1,610. That’s an additional $178 per month over 30 years, totaling over $64,000 in extra interest over the life of the loan!
If you don’t plan to pay cash for a new car, you’ll need a loan for that. You’ll be eligible to secure the best loan terms when you have better credit, like lower interest rates. And as we saw in the mortgage example above, the interest you pay matters in the short term (monthly payment) and the long-term (total cost over the life of the loan).
Credit Card Rewards
Some credit cards come with rewards for their customers. You might get 2% cashback on all purchases, 3% for travel, 4% for dining and entertainment, etc. If you pay off your card in full every month, these rewards are essentially free money! For example, it could enable your child to nearly pay for the spring break trip they want to take with friends.
But credit cards with special rewards often require strong credit scores, and if your score is on the lower end, you might not be able to access these types of cards and rewards.
The Mechanics of Getting A Good Credit Score
Now your child is all geared up about the importance of credit and the opportunities it can allow. But how should they go about building it up?
Building good credit isn’t an overnight process. It takes years of consistency and positive habits to build. Here are some ways to teach your kids to boost their credit scores over time.
- Timely Payments: Pay your credit card (and any other loan) on time every single month. Do not miss any payments or make late ones—seriously. When you miss payments, your bill compounds with sky-high interest rates, leading you into debt before you know it. Think about it as an assignment at school. When you turn something in late, the instructor usually takes points off. If you miss the project altogether, you’ll likely receive a “0”, which can tank your GPA no matter how good it was before.
- Credit Utilization: Third-party lenders like to see that you are not using all your available credit every month. For example, if your credit card allows you to carry a balance of up to $10,000 at any given time, you’ll want to use as little of that as possible. A good rule of thumb is to keep credit utilization under 30% (i.e., $3,000 of a $10,000 limit).
- Long Credit History: Doing the previous two items for an extended period will help your credit score. Opening a credit card at 18 and paying it off every month is a great way to start.
- Fewer “Hard” Credit Checks: When you take out a loan or open a credit card, the lender will do a “hard credit check.” Too many may indicate that you are stressed for cash which can hurt your credit.
Teaching your kids what goes into a strong credit score arms them with knowledge and sets them up for success. You can also tie these conversations into other money-related chats about spending with intention, setting goals, saving, etc.
Building Credit Before 18
Many credit card companies require the person opening the account to be 18 years old. If you want to introduce your kids sooner, many companies will allow you to make them an authorized user on the account.
When you make them an authorized user, it starts the credit building process earlier. If you want to teach good habits, you could have your child pay you back every month for some of their purchases.
Is Your Child Ready For This Next Step?
If your child is getting to the age where learning about credit makes sense, you may want to see how ready they are. Maintaining open lines of communication about money gives you and them space to ask questions and grow.
Perhaps you’ll talk through some of the following questions:
- How much are they spending?
- What are they spending their money on?
- Are they saving any money from the allowance you give them every week?
- What do they know about credit already?
The contents of this article are for general information and educational purposes and should not be construed as specific investment, financial planning, tax, accounting, or legal advice. Please consult with a professional advisor before taking any action based on the contents of this article.
All investment and financial planning strategies involve risk of loss that you should be prepared to bear. We cannot guarantee any investment performance whatsoever, and past performance is not indicative of potential future returns.