Good parents want the best for their children, and that includes having a good credit score when the time is right. It's important that you set a good financial foundation, teaching your child good money management, rather than try to build their credit history for them. It's like doing all their homework for them.
When it's time for your child to take the test, they'll fail because they haven't been doing the work themselves. The basic steps are to instill a solid financial foundation including a steady income and good checking account history, teach your child how credit works, and then help them get hands-on experience with a credit card of their own.
Before Your Child Gets a Credit Card
One early step you can take is to have your child get a job. The law requires credit card issuers to check income for applicants under age 21. Plus, your child needs a steady, reliable source of income to repay a credit card balance. An allowance doesn't count. Without their own income, your child might expect you to pay their credit card bill every month, especially if you've always paid for everything else.
Open a Savings or Checking Account
Establishing a good banking history can help your child build a strong financial foundation, which is a stepping stone for building a good credit score. Your child should get accustomed to making regular deposits into their account(s). Once your teen has a checking account, help them learn how to spend wisely and avoid overdrafts or declined debit card charges.
Make Sure Your Child Is Ready
Has she been managing her income well? Does your child make curfew and meet other deadlines? How well does he manage his checking account? Does he have to ask you for money to avoid overdrafts? If your child has other bills, are those bills paid on time?
Teach How Credit Cards and Credit Works
Make sure you clear up any misconceptions about how credit cards work and how good credit is built. Especially make sure your child understands that a credit card balance has to be repaid and the faster, the better.
Credit Cards Available for Your Child
Ideally, your child should build credit in their name alone, using accounts that don't require you to put your name and credit on the line. It is tricky since many credit card issuers require applicants to have a credit history. Your child can start by applying for credit at the bank or credit union where they've held a checking account. In-person may be better.
A retail credit card is another solo credit card option that your child can explore. These limited-purpose cards are known for approving applicants with little or no credit history. Credit limits are typically low, around $300 or $500. However, retail credit cards do have high-interest rates. If your child doesn't pay off the balance in full each month, they'll be paying high finance charges. Additionally, a retail credit card at your child's favorite store can lure them into going on shopping sprees.
Secured Credit Card
A secured credit card is another option. It's like a regular credit card, except it requires a security deposit against the credit limit. Some secured credit cards allow a minimum deposit of $200. You could help your child get a secured credit card by matching their security deposit.
You could jumpstart your child's credit history by adding him or her as an authorized user on one of your credit card accounts, or even a brand new account that you start just for your teen. An authorized user gets all the benefits of using the credit card and even has the credit history included in their credit report. But, the authorized user doesn't have legal responsibility for the debt.
By keeping your child as an authorized user, rather than a joint account holder, you still have control of the account. If your child becomes irresponsible and overspends, you can remove their authorized user status and close the account.
To keep things simple, let your child be the only one to use the account and have them pay the bill each month, ideally a few days before the due date. Sit down together and do this for the first few months, then let your child do it alone. Set a rule that the bill should be paid 2-3 days before the due date or else you'll have the account closed.
Using a Joint Credit Card
Getting a joint credit card with your child is risky because the responsibility is different. With a joint credit card, your child gets too much control with a product they're not familiar with and more importantly, a product that can affect your credit. For example, if you try to close the account, i.e., because your child was using it irresponsibly, your child may be able to open it back up behind your back.
Once your child has a credit card, teach them how to use it to build credit. Here are the key things your child should understand to build a good credit score. A credit card is a brand new experience. Make sure your child knows what to expect. Explain how credit card transactions work. Each month your child will get a billing statement. You can walk them through it, explaining the different sections. Most importantly, note the payment due date and put it on a calendar with other important dates and assignments.
Credit Reporting on Joint Cards
Their credit card issuer will report the credit card history to the credit bureaus every month. This credit reporting is how a credit history is built. Credit scoring companies use the information on credit reports to generate a credit score. Using a credit card the right way is important for building a good credit history and, therefore, a good credit score.
Payment history is the most important credit score factor. That means paying on time every month no matter what. It’s easier to pay the balance on time when you’ve limited purchases to what you can afford. So never charge more than you can afford to pay. Let your child know that you won’t be bailing them out each month if they go over what they purchase. If your child thinks they can depend on you to bail them out, they’re less likely to take responsibility for their credit card.
The amount of debt is the second-most important credit score factor. Teach your child only to use a portion of their credit limit. Thirty-percent and under is best. Make sure they know how to calculate 30% of their credit limit: Credit limit multiplied by .3, e.g., $500 X .30. Applying for too many credit cards in a short period of time is detrimental to a credit score. Credit card and loan applications show up on your credit reports for 2 years and affect credit scores for 12 months.