How to Have the "Credit Talk" With Your Teens
The words, “Charge It” may easily roll off our tongues, as common as “Good Morning” is in the course of our everyday language; however, the next time you reach for that card, remember that your kids are watching.
The process of using our credit card can be a convenient and healthy part of our financial lives, as long as the bills are paid at the end of the month; however, it can also create an unhealthy relationship with money. As I indicated above, all our kids see us do with money is spend it; they never see us pay the bills. Think about that.
When your kids become teens, it’s time to start the discussion about credit. The conversation is not just about the importance of credit and how to get it; more notably, the “talk” should be about how to handle it responsibly.
Your teen may be going off to college and embarking on the new world of financial independence. Being out on your own is exciting, but it also means that they will be treated as an adult with real financial responsibilities. They may still feel like kids, but the decisions they make today will affect them in the future, for better or worse.
Let’s start with the basics you’ll need to explain to your teens:
What Is Credit?
Credit is more than just collecting plastic cards in your wallet. Credit is a reflection of your trustworthiness. Good credit means that you have a history of making payments on all of your debt and that you are employed and can show that you earn enough to pay your bills. The benefit of having good credit is that more credit will be available to you and, in most cases, the interest rates you pay on loans will be lower. Employers can even look at your credit to ascertain if you are responsible.
Bad credit can be a big problem. It is usually the result of making late payments or borrowing too much money; therefore, overextending yourself. It may mean, that when you go to buy a car, rent or buy a home or get another credit card, you are turned down for credit. A negative credit history can haunt you for some time — as much as seven years or more.
Big Brother Is Watching
There are companies that keep track of whether you pay your debts and if you make those payments on time. The information is collected by three major companies: Equifax, Experian and TransUnion. They collect all of your credit data; your creditors report your payment history to them.
Most creditors use what is called a credit score to evaluate your credit record. When you apply for a loan or credit card, they look at your credit application, your annual income, your total debt (including any available debt that you could have if you used all of your credit cards or bank lines of credit), your bill-paying history, among other things. They look at “intangibles” as well, for instance, your applications to several different credit cards, which may mean that you were turned down and were scrambling to get more credit.
Fair Isaac Corporation, or FICO, produces the most commonly used credit scoring algorithm in the United States. They started in the 1950’s and ‘60’s by supplying credit risk scoring for the financial services industry. The name comes from the fact that they were started by William Fair and Earl Isaacs. The company actually went public in 1986 and then traded on the New York Stock Exchange.
Different lenders have different standards for evaluating the credit scores. According to the Federal Trade Commission, “Credit scoring systems enable creditors or insurance companies to evaluate millions of applicants consistently on many different characteristics.
To be statistically valid, these systems must be based on a big enough sample.” The range of scoring is from a low of 300 to a high of 850. According to Credit Karma, a score of “700 and higher… is generally considered good.” Your kids need to know their credit score. According to NerdWallet, “The average FICO score was 695…”
How Do You Get Credit If You Don’t Have A Credit History?
Your kids may have a challenge getting a credit card, particularly when starting out. As such, here are a few things for them to consider in order to establish credit:
- Apply for a credit card issued by a local store or a gas station. Local businesses may be more willing to extend credit to someone with no credit history. Make sure that your teen uses the card and then makes payments on a regular basis. This starts to build a sound credit history. It’s not enough to just get the card; it needs to be used.
- Apply for a secured credit card. In basic terms, this card requires you to put up the money first, in the form of a bank certificate of deposit, and then the bank lets you borrow from 50-100 percent of your own money on their card. They are reducing their risk. If you use the card and fail to pay it back, they have right to just take your deposit; however, if you use the card and pay on time, this shows that you are responsible. Your teen could graduate to an unsecured card and their deposit will be released.
- Co-sign on an account. Your teen could also ask you or others in their life with established credit histories to co-sign on a credit card account. By co-signing, the person agrees to pay back the outstanding debt, if your teen fails to.
The biggest message that you can convey to your kids is that a credit card makes it really easy to spend money. I guess Will Rogers put it best when he said, “Too many people spend money they haven’t earned, to buy things they don’t want, to impress people that they don’t like.” Make sure that that message gets conveyed as well.
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